Take off

On financial markets, the focus has been on central banks since weeks and months. The Federal Reserve (Fed) is certainly the most flexible of the “Big Three” – the Fed, the European Central Bank (ECB) and the Bank of Japan (BoJ). This has also been evident over the past decade, as it was the only one of the trio to complete a full interest rate cycle. Now, the Fed is once again ahead of the ECB and the BoJ and ready for take-off in the first quarter of this year.

Other central banks are already further ahead than the “Big Three” in normalizing monetary policy. Thus, after a first rate hike of 15 basis points in December 2021, the Bank of England (BoE) last week already announced its second rate hike by an-other 25 basis points. Further interest rate steps by the BoE are expected to follow this year. In addition, more and more central banks are scaling back quantitative easing, including the Royal Bank of Australia (RBA). The supply of liquidity is thus being steadily curtailed, and rising rates are likely to create additional headwinds on global capital markets.

ECB changes its rhetoric

The focus is now shifting to the number two of the central banks, the ECB, which has also recently adjusted its rhetoric. At last week’s press conference following the monetary policy decision, ECB President Christine Lagarde no longer explicitly ruled out a rate hike in 2022. The last time the ECB raised interest rates was in 2011. The chairman at that time was Jean-Claude Trichet. His successor Mario Draghi never tightened monetary policy during his eight-year term. The Italian gained wide recognition in July 2012 when, during the height of the euro crisis, he declared that the ECB would do “whatever it takes” to save the euro.

Financial markets currently expect the ECB to raise interest rates five times this year, by 10 basis points each time (table 1). The eurozone has experienced a small taper tantrum over the past two months, as rates at the long end have risen between 60 and 100 basis points. Even ten-year German government bonds are now yielding positive, after being in negative territory for almost three years. We think that markets view the ECB’s interest rate hike path as too aggressive, just like in the United States and the UK.

Financials remain attractive

The withdrawal from quantitative easing, the upcoming interest rate hikes and a possible reduction of central bank balance sheets (quantitative tightening) are steps in the normalization process of global central banks after the corona crisis. This means stronger headwinds for all asset classes. In the coming weeks, we anticipate continuous upward pressure at the long end of the yield curves of G7 nations. Thus, we continue to recommend a shorter duration and to maintain an underweight in government bonds. Rising interest rates, especially in the eurozone, benefit financials. We therefore continue to view European banks and insurance stocks positively.