(Bloomberg) — After standing shoulder-to-shoulder for much of the pandemic, traders are preparing for the day the world’s central banks begin to move apart on policy.
Though little movement is expected for at least the next year, futures markets suggest the Federal Reserve will hike rates in late 2023 and the Reserve Bank of Australia in 2024. New Zealand looks ahead of the pack with a hike priced in for late 2022. In Europe and the U.K., the likelihood of additional cuts is still being debated, while in Japan, a further move lower remains stubbornly priced in.
Evolving expectations this year for when each central bank will next move are a break from 2020 when investors saw policy makers act almost as one to cut rates and boost asset purchases to help stave off economic collapse. Divergent policy paths can make one country’s bond market more attractive than another’s, opening up relative trade opportunities for investors.
Here’s a look at how the recent shifts are impacting markets:
U.S. on Pole, Europe a Non-Starter
With market-based measures of inflation rising, swap markets are slowly cranking up the pace of expected U.S. rate hikes. Traders are bracing for a first 25 basis point hike in the fourth quarter of 2023, then another 50 basis points over the next 18 months. That’s a slower pace than the last hiking cycle, suggesting there is room for more to be priced in.
That stands in contrast to Europe, where some central bankers continue to dangle the threat of rate cuts, not least as a means to counter strength in the euro. Market pricing suggests the first European Central Bank hike won’t come till 2024 and rates won’t climb into positive territory for the guts of a decade. That suggests the path for a further widening in rate expectations versus the U.S. looks open.
The divergence is showing up in the market, with short-term European bonds outperforming their U.S. peers in recent months. A Bloomberg Barclays gauge of 1-3 year European government bonds is up almost 0.60% since the end of September, compared to a rise of just 0.1% for the Treasuries equivalent.
The Reserve Bank of Australia have given a sense of stability to bond bulls, by extending guidance on its rate policy to 2024 and pledging more asset purchases. That has anchored short-term pricing for rates, though market pricing suggests traders expect the possibility of a quick series of increases thereafter.
Across the Tasman Sea, investors have been pulling bets that the Reserve Bank of New Zealand would turn to negative rates after a string of positive data surprises. In late October swap markets priced a full 50 basis points of cuts down to -0.25%, but that had been cut to zero last week. With the RBNZ now seen as having a freer hand, forwards suggest it will raise rates sooner than the RBA.
The moves have hit an ICE Bank of America gauge of short-dated New Zealand government bonds, which has fallen about 0.6% from the end of September, compared to a near 0.2% rise in the Australian equivalent.
U.K. and Japan
Over in the U.K., where the Bank of England are still toying with the idea of rate cuts, traders got a hawkish jolt on last Thursday. The central bank was at pains to stress that having the option of negative rates doesn’t mean they will be used, especially as it expects inflation to rise “sharply” toward its 2% target in the spring. That caused a rise in rate hike expectations for 2023.
Meanwhile in Japan, rate-cut pricing remain bulletproof. The Bank of Japan is looking at how to make monetary easing more sustainable, opening the door to a reduction in bond buying and increasing the likelihood of rate cuts as a policy tool.
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