Relief rally for bonds and equities now that central bank uncertainty is over

Equities and bonds are rallying together on Thursday, as a mixture of a declining oil price and a reassessment of last night’s Fed decision boosts sentiment. Yields are tumbling in the US and in the UK, after the Bank of England held rates steady earlier today. 

Below we take a look at three main drivers of price action as we move into the end of the week: 

• The oil price: Brent crude is lower by 1.6% today and in the last 5 days Brent crude has fallen by 5%. It is currently trading above $104 per barrel, which is an elevated level, but the oil price did not reach extreme highs even after the Saudi Arabian East-West pipeline was attacked last week. There have been two developments that are weakening the oil price this week. Firstly, the Saudis have said that the fix to the pipeline is fairly easy, and 50% of capacity could be back on line in the coming days. Secondly, Chinese authorities have urged the Iranian government to control the Houthis. This may limit further attacks on key Gulf oil sites. Energy prices remain elevated, but the worst has not come to pass. This is why Brent looks comfortable below $105 per barrel, although a deeper decline will require a ceasefire or some sort of deal between the US and Iran in the coming weeks. 
• The Fed: the Federal Reserve hiked interest rates on Wednesday and also signalled that rates could rise further. The FOMC’s median estimate for interest rates is 4.1% so one or two further hikes are likely. Although yields initially rallied on a ‘hawkish’ Fed, there has been a relief rally for stocks and bonds on Thursday, as the uncertainty of what the Fed will do next is now out of the way. This suggests two things: 1, forward guidance, even in the form of a Dot Plot, is useful for anchoring the bond market, and 2, unless energy prices move materially higher from here, then inflation could stabilise. The Fed said that there were three factors that drive interest rates right now: 1, the economic data, 2, inflation expectations and 3, geopolitics. If the 3rd point is resolved in the coming weeks, then further rate hikes may not be deemed necessary. 
• The BOE: it voted to keep rates on hold at 3.75% today, bucking the trend for higher rates. The vote split was 6-3 in favour of holding, and the BOE sounded fairly upbeat about the growth outlook, with GDP set to expand by 0.4%, even with the backdrop of higher energy prices. The BOE also paused its quantitative tightening programme, which has helped the Gilt market to recover, especially at the long end of the curve. The 10-year yield is down 5bps, the 30-year yield is lower by 10bps since the announcement. This creates some breathing room, as the BOE sits on its stock of long-dated debt rather than actively selling it, bringing it more in line with other developed central banks. If we continue to see UK Gilt yields moderate in the coming weeks, then this would suggest that the BOE’s QT programme was adding a significant premium to UK debt. It is also a welcome boost for the chancellor ahead of the October budget. On the inflation front, the BOE governor said that, so far, there were no clear signs that the energy price spike was having second round effects on inflation, however, he warned a rate hike would be possible if the geopolitical situation and energy supply crunch persists. The prospect of a rate hike in November is still live, but a prolonged rate hiking cycle is now less likely. This meeting has put to bed the prospect of 5 rate hikes from the BOE in the next year, and GBP/USD is lower on the day and is trading around $1.3350. The pound is the weakest of the main currencies today, and we think there could be room for further GBP downside, with $1.31 a major support zone for GBP/USD. 

The baton is now passed to the Bank of Japan, who announce their policy decision tomorrow.  While they are also expected to hike rates by 0.25%, they may also temper their message, looking for further evidence of second round inflation effects before they hike interest rates further.