Markets Pricing in Central Bank Rate Increases Over the Next Year

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As inflation continues to rise around the world, central banks are trying to counter rising prices by stopping their respective buying programs and raising interest rates. Most of the major central banks have completed their Quantitative Mitigation programs, with the exception of the ECB and the BOJ (however, the ECB is expected to complete it very soon). This raises interest rates as the main tool for combating inflation.

The chart below shows where some of the major central banks currently have interest rates and where the markets expect them to be in one year.

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Source: Stone X

The ECB is the latest in raising rates at -0.50. However, markets expect rates to be close to 1.0% in 1-year. With inflation in the Eurozone pushing 7.5% YoY, ECB members, including ECB President Christine Lagarde, have been on the wires in recent weeks discussing the possibility of a tariff hike right in July.

The Bank of Japan also has ultra-low rates at -0.10, however markets are only expected to see rates in Japan rise to 0.3% in 1-year time frame. This is mainly due to the deflationary pressures that Japan is facing. Indeed, as part of the BOJ’s QE central bank, it continues to buy ETFs in the market and set the 10-year yield at 0.25%. If yields rise to that level, the central bank will step in and buy JGBs to keep yields low.

The Fed currently has the Fed Funds rate at 1.0%. However, markets predict that the Fed will raise rates to 3.22% in 1 year. With inflation nearing 40-year highs at 8.3% YoY, several Fed members have suggested they may need to raise rates above what the Fed considers neutral, at about 2.5%, to lower inflation. It should be noted that the Fed is targeting 2% inflation, so there is a long way to go before inflation reaches the Fed’s target level.

The BOE currently has rates set at 1.0%. Markets see rates rising to “only” 2.41% in 1-year. Although inflation in the UK is high, as with other countries, the MPC is taking a more cautious approach. The BOE knows that it needs to raise rates to combat inflation, yet at the same time the central bank is concerned about the impact of inflation and rising interest rates on household incomes and growth. Indeed, the March GDP reading was -0.1%, suggesting the BOE may be up to something!

The BOC, RBA, and RBNZ are in similar situations. Everyone is facing high inflation but is also worried about slowing growth. If one throws the recent locks in China into the mix, there is an even greater chance of a global slowdown.

Traders should look at the change in rate expectations against current rates. Because foreign exchange rates are affected by the difference between 2-country interest rates, having an idea of ​​where interest rates can be headed can be one tool investors can use to help determine where FX exchange rates might go next!

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