Markets Wrap (1 – 18 December)

Stocks

As the worst year for European stocks since 2018 is coming to an end, strategists do not see a major rebound in 2023 – according to the average response in a Bloomberg survey, Stoxx Europe 600 should finish 2023 at 449 points indicating a gain of less than 5% (Chart 1). Economic slowdown, rising rates, energy crisis and inflation are among reasons cited by investment professionals for their downbeat forecast. 

Bonds

The German bond market is giving a clear indication that the country's economy, plagued by high energy prices, is headed for hard landing. 2-year sovereign yield turned higher than that of 10-year bonds for the first time since the pandemic struck in March 2020, whereas economists place a 90% probability on an economic slump within 1 year (Chart 2).

Central banks

Following four 75 bps hikes, the FED tightened by 50 bps (to 4.25-4.5%), but the market found little consolation in the smaller move. The stock market rally that followed the meeting quickly fizzled out on fears that interest rates will rise more slowly, but to a higher level than previously thought. The updated FOMC dot plot (Chart 3), which is used by the FED to signal its interest rate outlook, shows the median end-of-2023 projection at 5.1%. 

The ECB raised key rates by 50 bps to 2.0% (deposit), 2.5% (refinancing) and 2.75% (lending), but the communication part was a lot more interesting than the decision itself. According to Ch. Lagarde, a smaller hike (50 bps versus two previous 75 bps) does not mean a pivot in the monetary policy, and further tightening is to be expected. Besides, important details on the future implementation of asset purchase programs were provided. Starting with April 2023, net purchases will turn from zero to negative by EUR 15bn monthly for starters, with the scope of tightening beyond Q2 yet to be decided. Bloomberg later cited 'knowledgeable sources' that the agreement on a smaller 50 bps move was only reached by the Governing Council on a condition of a clear communication about future hikes and the upcoming quantitative tightening. Market expectations of the maximum interest rate in the euro area jumped by some 40 bps to 3.30% (Chart 4) following the December meeting – the market expects this level to be reached in September 2023.

The Bank of England raised the key rate by another 50 bps (to 3.50%), but the December meeting outcome was clearly perceived as dovish by the market, as policymakers seem to think that worsening economic indicators justify a slowdown in the hiking cycle. Interest rate futures indicate an expectation that rates will peak at 4.7% in September 2023. EUR/BGP rose by 1.5% (to 0.873) on an overly careful communication (the Monetary Policy Committee alluded to a considerable uncertainly surrounding the economic outlook) and ECB's hawkishness. 

The Norges Bank lifted the key rate by 25 bps (to 2.75%) and indicated that another hike is upcoming at the beginning of 2023. The updated interest rate path implies the maximum rate of a little over 3%.