Most of the market gyrations we experienced this year were somehow linked to the direction of interest rates and the communication provided thereon by major central banks. While a so-called pivot to rate cuts does not seem imminent at this stage, we have over the past few weeks observed various signs of a potential slowing down from the recent hefty pace of rate increases by major central banks. 

The latest evidence of this was last Thursday when, following the release of a slower-than-expected inflation print in the US, four Federal Reserve officials signalled a desire to moderate the pace of interest rate increases. This raised the odds for a smaller move of 50 basis points (bps) by the Fed next month to 85 per cent, up from roughly 50 per cent the previous day. Moreover, it also ignited a rally in financial markets because it hinted to investors that the Fed might not have to raise rates quite as high as previously anticipated to bring down inflation.

Even before Thursday’s inflation report, the Federal Reserve in its last meeting in early November already appeared to signal an intention to slow the pace of rate hikes from 75 bps to 50 bps in December, while noting that the ending point for rates may be higher than markets have been expecting. The Fed’s announcement is indeed part of a trend seen in recent weeks that suggests a nearing end to the rate hiking cycle.

Other major central banks have also pulled back from aggressive rate hikes in October and some even halted their hikes. The Bank of Canada surprised markets by hiking at a smaller rate of 50 bps in October rather than the expected 75 bps. The Reserve Bank of Australia had already hiked by 50 bps for four straight meetings but surprisingly announced a slower pace of 25 bps in October and again this month. Also, in November, the Bank of England voted 7-2 to lift rates by 75 bps to 3 per cent, the highest level in 14 years. But in contrast to the Fed, they issued an unusually blunt comment on investors’ outlook for future hikes, stressing the peak in rates will be “lower than [what is] priced into financial markets.”

The European Central Bank hiked rates by 75 bps for the second straight meeting in October. However, its remarks about the economy sounded more cautious and eliminated the word “several” from the number of hikes remaining. There were also reports that three voters wanted a smaller hike at the October meeting. The ECB said it has more work to do on inflation and future hikes are both data-dependent and would be considered meeting by meeting. The outcome was to lower market expectations for the peak in the Eurozone next year by 50 bps.

Stepping down from aggressive rate hikes could help boost equity markets as we saw last week. Since signs of a slowing down began to emerge at the start of October, the MSCI World Index of international equities across developed countries climbed by over 10 per cent. Equity markets outside the US that are outperforming the S&P 500 Index this year include many countries where central banks are slowing down the pace, including Canada, Norway, the UK, the Euro Area, Australia, and Brazil.

There can be no guarantee that central banks will continue to decelerate the pace of their hikes or pause them, but it they do it is possible that the current market rally could extend further into the year’s end. That would be a welcome development for investors who are still recovering from double-digit declines this year across the traditional asset classes of bonds and shares.