Market sentiment changed yesterday after the Bank of Canada (BOC) surprisingly raised the reference rate by 25 bps, bringing stock indices down.
The expectation that the Federal Reserve (Fed) will hold off on raising rates at its upcoming meeting as it monitors the impact of its tightening monetary policy on inflation and the economy, which has been showing signs of weakness, helped the stock market open higher yesterday. However, there was also concern that higher interest rates might spark new turmoil in the US banking industry. In fact, Treasury Secretary Janet Yellen said yesterday that she did not completely rule out the possibility of future bank mergers, even suggesting that doing so would be beneficial for the stability of the system.
But an unexpected event changed the market situation. The BOC, which met yesterday to discuss interest rates, raised the reference rate by 25 bps, surprising the market that expected the rate to remain unchanged.
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The BOC's report was more "hawkish" than anticipated and while the central bank expects inflation to continue on its downward path, officials have stated they will keep monitoring price developments and implied that they may continue to raise rates. In fact, following this decision, the market started to discount at least one additional rate increase in the interest rate futures market. The rest of the markets, especially North American, have been affected by this shift in expectations concerning the Canadian monetary policy after a similar event occurred in Australia.
Since the conditions are different, the BOC’s decision should not, in theory, influence the Fed's decision, but among investors, there seems to be a growing mistrust of coordinated activities among central banks.
Investor bets for a halt at the next Fed meeting have significantly decreased as reflected in the US fixed income market, where Treasury rates increased by 10 bps across all benchmarks along the curve.
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Since the yields on European bonds also increased as a result of the BOC’s, the value of the Dollar did not significantly change after this unusual rise in interest rates. Only about 20 pips were lost in the EUR/USD.
But the stock indices abruptly shifted course, particularly the technology Nasdaq, which is the most rate-sensitive and dropped by around 1% from its 12-month high and from the overbought region.
Sources: Bloomberg, Reuters