Hendrik Tuch, head of Fixed Income NL at Aegon Asset Management, shares his views on the markets for 2022, cautioning that markets will have no reason to party after the end of dry January.
Financial markets are facing a global synchronised tightening with expectations of many back-to-back rate hikes and even the likelihood that major central banks could implement 50 basis points hikes to speed up the process. In addition, we will likely see central banks withdrawing liquidity at a speed never seen before. As a result of these changes, we might face in total up to 3 trillion USD of liquidity being withdrawn by central banks in the next 18 months. That equates not to “dry January” but to a closure of all liquor stores for the rest of the year.
Central banks are also doing their best to wean us off our liquidity addiction and last week we saw once again clear signs of their determination to fight rising inflation numbers.
The Bank of England was first to warn the market of more monetary pain ahead with its second rate hike in this cycle. It was a close call for a 50 basis points hike, with four members of the Monetary Policy Committee voting in favour of this versus five members voting for 25 bps. Keeping this in mind, as well as the BoE’s expectation that inflation will average 6% in 2022, financial markets now predict a hike in March, May and June meetings. If back-to-back hikes ensue, it would be the fastest tightening cycle since the Bank of England was granted operational independence to set monetary policy in 1997.
Once the official rate moves up to 1%, the BoE will likely start to consider reducing its balance sheet by selling existing gilt holdings, while the bank has already announced it wants to get rid of its corporate bond portfolio. The UK bond market was clearly less than pleased with this outlook while the UK audience was infuriated by the message of Governor Andrew Bailey that, in order to avoid inflation pressures becoming entrenched, they should not ask for big pay increases.
The European Central Bank was also forced to warn the market of impending change in its monetary policy stance. While the official statement did not change much versus the previous meeting in December, in her subsequent Q&A session ECB President Christine Lagarde turned very hawkish. She mentioned the Governing Council was unanimously concerned about recent inflation data and no longer ruled out a rate hike in 2022. Financial markets and many economists were shocked by these announcements and within minutes the European money market curve had priced in at least two hikes for this year.
Lagarde reiterated that the ECB will not hike rates before it has ended its buying programme – this only adds to the hawkishness of her message as markets will not only face a removal of the negative interest rate policy but also a quick end to quantitative easing.
‘Taking the punchbowl’ away has been a popular term to describe previous central bank hiking cycles. The idea is that central bankers will ensure the financial market ‘party’ does not get out of hand by withdrawing monetary stimulus on time. No one gets (too) drunk at the party, thus no major headaches the next morning and we can look forward to the next civilized neighbourhood party.
However, during the last decade the collective central bank community has not put a standard sized punchbowl on the table but instead filled an entire swimming pool with Long Island iced tea for markets to enjoy. When Covid-19 started, central banks ramped up the drinks again. This party has got way out of hand and now we are left with a major headache.
