A Tale of Two Central Banks

The US Federal Reserve tightened policy for the 7th time since 2015, raising the range on Fed Funds 25bps to 1.75% - 2.0%. More notable was the update to the committee’s median expectation for policy rates, which shifted from 3 to 4 rate hikes in 2018.

In Citi’s view, the Fed could raise rates at least once more in 2018, followed by at least 3 hikes in 2019. Fed officials are clearly focused on continued normalization. However, subdued inflation creates little urgency to accelerate the gradual pace.

Still, short rates in the US are likely headed higher and as such, hedging floating-rate liabilities, or adding exposure to floating-rate assets could remain important for investors.

The European Central Bank (ECB) announced the taper of its bond purchases to end September, to €15 billion from current €30 billion, for three months before stopping purchases after December. But the ECB expects key interest rates to remain at their present levels “at least through the summer of 2019”. This potentially extends the timeline for the first ECB rate hike from 6 months to 9+ months from the end of December 2018.

Citi analysts expect renewed fixed income price pressure and remain underweight in sovereign bonds. The scale of ECB bond buying relative to the size of the European bond market is significant (and bigger than the Fed buying in the US), so even as the ECB continues to reinvest maturing bond proceeds Citi would expect the European fixed income universe to need higher yields in order to attract sufficient buying interest from the private sector.