Federal Reserve chief Jerome Powell warned on Wednesday that recent signs US inflation may be slowing, yet there is no confidence that the battle has been won.
Forget the year-end rally in the financial markets. The message from major central banks is loud and clear: The fight to contain inflation is not over.
Central banks in the United States, the euro zone, Britain and Switzerland met on Wednesday and Thursday and all slowed the pace of aggressive rate moves.
But his signal was not what markets, which have been reeling under the impression of extreme inflation and extreme interest rates in recent weeks, wanted to hear.
European Central Bank President Christine Lagarde said more 50-basis-point rate hikes were expected for some time and that the ECB was not "pivoting" yet.
It raised rates by 50 bps on Thursday after delivering two back-to-back 75 bps moves to tame double-digit inflation.
There was a boom in the government bond markets. Owing to the fall in prices, the yield on interest-rate-sensitive two-year German bonds rose 24 bps, the biggest one-day jump since 2008.
Italian borrowing costs were up nearly 30 bps at 4.13%, while European shares fell nearly 3% and stocks on Wall Street fell 2%.
"The reaction in European bond markets has been brutal," said Antoine Lesnay, head of EMEA strategy and research for State Street's SPDR ETF business.
A slight drop in euro area inflation to an annual rate of 10% in November had fueled market speculation that the ECB might step aside from its fight against rising prices.
"Markets were getting ahead of themselves about the euro area in the last few weeks ... they are now reiterating the fact that the ECB will have to be dovish," Lesne said.
Ed Hutchings, head of rates at Aviva Investors, said he expected peripheral European bonds to "struggle" from here and that European bonds in general would be somewhat less supported.
Very Satisfied?
Federal Reserve chief Jerome Powell meanwhile warned on Wednesday that recent signs that US inflation may be slowing did not yet give any confidence that the battle has been won.
"Forget the Santa rally...the Fed looks more like the Grinch this Christmas," said John Leeper, CIO of Titan Asset Management.
The S&P 500 fell to its lowest level in a month on Thursday. The index jumped 2.76% to a three-month high on Tuesday, as an unexpectedly small increase in consumer price inflation raised hopes the Fed could soon roll back its rate hike. The S&P has declined more than 16% this year.
Switzerland's central bank chief Thomas Jordan also weighed in after the 50 bps hike, saying it was too early to "sound the all clear" on inflation.
"It looks like major central banks, including the Fed, are having to contend with the market story of relief," said Hetal Mehta, senior European economist at Legal & General Investment Management.
Recent data in the United States and Europe showed inflation eased slightly, pushing bond yields to multi-year highs and the S&P 500 jumping more than 10% from October lows.
While the U.S. 10-year Treasury yields are still set to end the year up 200 bps, down 32 bps in Q4, their biggest quarterly decline since the start of 2020. The yield on the German benchmark Bund is also up more than 200 bps. 2022 but is about 50 bps lower than the multi-year high of 2.5% reached in October.
Such sharp moves loosen the financial conditions that central banks are trying to tighten to control inflation.
Speaking at a post-decision news conference on Thursday, the ECB's Lagarde made reference to the financing situation and said further tightening was needed.
"The market rally will be ease of financial conditions, which is troubled by the idea that they (policy makers) need to get interest rates in the restrictive zone," Mehta said.
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