Markets pare rate hike bets as West gets tough on Russia

Investors further reduced bets on Monday for interest rate hikes from major central banks this year, as the West ramped up sanctions against Russia for invading Ukraine, creating fresh uncertainty about the world economic outlook.

Aggressive rate-hike bets priced in by markets from the likes of the U.S. Federal Reserve, Bank of England and European Central Bank had already come off in the past week.

But they eased further on Monday, with money markets increasingly confident that the ECB will move later rather than sooner since tougher Russia sanctions which include blocking some banks from the SWIFT global payments system and an oil price surge will hurt the euro zone economy.

Rate futures significantly pared back the odds of a 50 basis-point tightening by the Fed at its meeting this month to 6.5% late on Monday, from about 23% roughly a week ago. It was as high as 70% early in the month after U.S. consumer price data showed annual inflation hitting a 40-year high.

The Fed, however, is widely expected to push through with a quarter-point rate increase at the two-day March meeting.

Fed Chair Jerome Powell will appear before Congress this week for his semiannual Monetary Policy Report testimony in the final week leading up to the pre-meeting blackout period.

“The near-term effects of the crisis appear to be inflationary, but the hit to growth is tougher to discern and puts central bankers in a very tough spot,” wrote Wells Fargo in a research note.

“We expect Chair Powell to hint strongly in his congressional testimony that the Fed will go 25 basis points, not 50 basis points, at the March 16 meeting.”

In Europe, markets have fully priced in a first, 10 basis- point rate hike from the ECB at its September meeting, having positioned for a June move following the ECBs hawkish pivot earlier this month .

They anticipate 30 basis points worth of tightening in total by year-end, or the equivalent of three, 10 bps hikes. Thats down from 35 bps late last week and as much as 50 bps just a couple of weeks ago.

“It is logical for curves to shave off the likelihood of rate hikes in Europe and the U.S.,” said ING senior rates strategist Antoine Bouvet. “It is too early to assess the economic impact of the current crisis but the impact on growth will be negative, we just dont know by how much.”

A Bank of Canada meeting on Wednesday could prove a gauge of how central banks in the West are assessing the potential impact of Russias attack on Ukraine on their growth and inflation outlook.

Canadas central bank is widely expected to lift rates by 25 basis point in its first hike since October 2018, with just over six rate moves in total priced in by year-end.

The Bank of England is also expected to lift rates by 25 bps in March, although bets on a more aggressive 50 bps hike have come off the table.

ECB chief economist Philip Lane has told fellow policymakers that the Ukraine conflict may reduce the euro zones economic output by 0.3%-0.4% this year, four people close to the matter told Reuters on Friday.

“It becomes very tricky for them to navigate, especially the ECB, whereas for the Fed this will be more an inflation issue than a growth issue, so they will continue to tighten – maybe not 50 bps but 25 bps – they dont want to be the source of theatrics in this environment,” said Salman Ahmed, global head of macro at Fidelity International.