Yield outlook – New chair cements outlook for rate hikes

A more conciliatory tone between the US and Iran, alongside a small increase in shipping traffic through the Strait of Hormuz, has eased pressure on energy prices and pushed oil below USD80 per barrel. This has fed through to European rates, which have declined by approximately 0.10 percentage points across the curve. In the US, long-term inflation expectations have begun to decline again, supported in part by a Federal Reserve (Fed) signalling rate hikes and a clear desire to bring inflation back to target. This has led investors to further increase their expectations for rate hikes from the Fed in the second half of the year. Central banks remain focused on the risk of too high inflation. A series of rate hikes are now expected across economies, and over the past month several central banks have delivered rate hikes.

A regime shift at the Fed?

Since our latest Yield Outlook publication, new Fed Chair Kevin Warsh has held his first meeting of the FOMC. The meeting was a clear signal that the Fed is increasingly moving away from using forward guidance around upcoming monetary policy decisions, and all indications suggest a preference for greater discretion around future policy decisions. Despite this, it was evident that there was an inclination towards rate hikes, with half of the members indicating an expectation of 1-3 rate hikes over the coming year. The inflation forecast was also raised considerably, and the committee now sees upside risks to inflation. Relative to the previous meeting, members now see the possibility of both stronger and weaker growth and labour market conditions. We expect the Fed to deliver two rate hikes in December 2026 and March 2027, respectively, which would bring the benchmark rate to 4.00-4.25%. We do, however, emphasise that there is a risk that rate hikes could come sooner, and that more than two could materialise.

ECB: Inflation risks dominate

Earlier this month, the ECB delivered its first rate hike since September 2023, emphasising that the decision was robust across different scenarios. ECB President Lagarde placed considerable weight on the risk of higher inflation and appeared less concerned about the deteriorating growth outlook. She did note, however, that there so far are no signs of more persistent inflationary pressure, even as some expectation of rising prices exists among businesses across sectors and categories. The European economy continues to show increasing signs of weakness, and we increasingly expect this to spread to the manufacturing sector as well. We assess that tensions in the Middle East are negative for the growth outlook, which we (following one further rate hike in September) expect will trigger two rate reductions in the first half of 2027.

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