The December calendar for central banks' meetings (Federal Reserve and European Central Bank) is likely to shape investors’ expectations for monetary policy in 2022
The lack of negative news regarding Omicron variant led risk markets higher in the past week, albeit volatility resumed on Monday. The S&P500 is trading at 21.4 times 12-month forward earnings of $221, down from 22.6 times one year ago.
The increase was broad-based, with all S&P500 industry groups (24) ending the week in positive territory. On the other side of the Atlantic, European equities increased by +2.6%, also with limited return dispersion. Speculative corporate bonds rallied, with USD spreads declining by 27 bps to 329 bps and EUR spreads narrowing by 16 basis points to 342 bps, remaining though circa 25 and 55 bps higher, respectively, from their mid-2021 lows.
Geopolitical tensions, as Russia has been moving military forces toward the border with Ukraine with a scale at least twice relative to past spring’s operation, have mainly affected natural gas prices. Moreover, the US is putting pressure on Germany to block, the newly built but not yet approved, Nord Stream 2 gas pipeline if a Russian invasion takes place.
As a result, the price of wholesale Dutch TTF benchmark has increased by 14% month-to-date to EUR106/MWh and the December 2022 future contract by 56% to EUR69/MWh, with wholesale electricity prices following suit. Gas prices are expected to remain at high levels until Spring 2022.
On the Federal Reserve, Chair Powell has supported a potential acceleration in the pace of tapering. Large-scale asset purchases are now likely to end in March 2022 instead of June 2022, with Fed reducing Treasury and MBSs purchases by $30B per month instead of $15B per month and balance sheet expansion since March 2020 amounting circa $4.5T to $8.7T (38% of 2021 GDP).
A speedier taper will provide FOMC members optionality to increase interest rates sooner, if warranted by fundamentals, based on 2014/2015 sequence’s playbook. According to our estimates, the median of FOMC members’ assumptions for the appropriate path of the Federal Funds Rate (“FFR”) will point to the FFR reaching the longer-term rate of 2.5% (as estimated in September 2021) in the end of 2024, versus an assumed appropriate FFR of 1.8% in end-2024 in September’s projections.
Such an upward revision would come in view of stronger inflation and unemployment rate outcomes in Q4:2021 compared with September’s projections, while real GDP (Q4/Q4 is expected at circa 6%) has broadly confirmed expectations.
The ECB (December 16th) is set to discuss the future of QE after the PEPP’s planned end (March 2022), albeit calls to delay the respective decisions have grown, due to the pandemic uncertainty. Recall that the total envelope of PEPP is €1.85T, while holdings amount (as of December 3rd) to €1.55T with a low likelihood of an extension of the current PEPP past March 2022.
Regarding the Bank of England, investors (according to sterling overnight index swap rates) appear split on a potential rise in the Bank Rate from +0.10% to +0.25% as soon as at the next meeting (December 16th), fully pricing in such an event though, in the February 3rd 2022 meeting.