Bond Yields Fall Despite Today’s Large ECB Rate Hike

The markets interpreted the outcome of today’s ECB meeting as a “dovish tighten.”  As a result, the 10-year German bund yield today is sharply lower by -13 bp at 1.98%.  The 10-year T-note yield is down -9 bp at 3.91%.

The European Central Bank (ECB) today raised its key interest rates sharply by +75 bp, but seemed to back off its guidance for further sharp rate hikes.  The ECB said in its post-meeting statement that it “expects to raise interest rates further.”  However, there was no mention of expectations for further sharp rate hikes.  ECB President Lagarde said that the ECB might well still hike at several more meetings, but that at least put somewhat of a time limit on the ECB’s rate-hike regime.

Specifically, the ECB today raised its 2-week refinancing rate by +75 bp to 2.00%, for its third rate hike.  The ECB has now raised the refinancing rate by a total of +200 bp from the 0% level that was in place from 2016 through June 2022.  The refinancing rate is the interest rate that banks pay when borrowing reserves from the ECB at its regular money market operations.

The ECB today raised its deposit rate by +75 bp to 1.50%, up by a total of +2.00 percentage points from the -0.50% level that was in place from 2019 through June 2022.  The deposit rate is the interest rate that banks receive when they keep excess reserves on deposit with the ECB.

The markets are expecting the ECB to raise rates by at least another +50 bp at its meeting in December. A further +25 bp rate hike is then possible in early 2023.  However, the markets are then expecting the ECB to sit back and reassess the situation as it waits to see how the European energy crisis plays out, whether inflation eases, and whether the Eurozone economy falls into a deep recession.

The markets are hoping that the days of +75 bp rate hikes will soon draw to a close.  The Canadian central bank on Wednesday raised its key rate by only +50 bp versus market fears of a +75 bp rate hike. 

The markets are expecting the FOMC at its meeting next week to raise its federal funds rate target by another +75 bp to a range of 3.75%/4.00%, up by a total 3.75 percentage points from the 0.00%/0.25% level that was in place from March 2020 through February 2022 due to the pandemic.

However, the markets are expecting next week’s +75 bp FOMC rate hike to be the last.  The markets are expecting a smaller +50 bp rate hike in December and a further +50 bp worth of rate hikes in early 2022, according to the federal funds futures market.

The Fed is expected to halt its rate-hike regime by spring 2023, with its funds rate peaking at 4.86% in May 2023.  That would be up by a total of +178 bp from the current effective federal funds rate of 3.08%.

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