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Fed Rate Hike Pause Benefits US Bonds and European Stocks

The Federal Reserve's rate hike pause boosts optimism for US bonds and European stocks while contrasting with European central banks' ongoing rate increases and changing market dynamics amid banking turmoil.

Jerome Powell
Jerome Powell

The Federal Reserve's decision to pause rate hikes before its European counterparts have led to optimism for US bonds and European equities. On Wednesday, the Fed implemented a modest 25 basis-point rate hike, with Chairman Jerome Powell hinting that increases may soon cease due to the need to assess the impact of banking turmoil on financial conditions.

European Central Banks Continue Rate Hikes

Despite the Fed's cautious stance, European central banks pressed on with rate hikes on Thursday. The Bank of England and Norway both increased rates by 25 basis points, while the Swiss National Bank raised rates by 50 basis points. Norway and Switzerland also signaled more increases in the future, emphasizing the contrast between the Fed's cautious approach and the European banks' confidence in dealing with banking concerns.

Investors Favor European Banks Over US Counterparts

Many investors believe that Credit Suisse's problems are unique and that European banks are better regulated. They also anticipate that smaller US lenders, at the heart of the banking turmoil, will significantly impact the US economy, thus increasing recession risks in the world's largest economy. Consequently, investors are more bullish on European stocks than their US counterparts.

Uncertainty Surrounding Future Rate Hikes

The outlook for future rate hikes remains uncertain, with the Bank of England and the European Central Bank potentially continuing to tighten monetary policy. Market turmoil may influence the ECB's actions if it suppresses demand and inflation. Bank of England Chief Andrew Bailey was uncertain whether Thursday's rate hike would be the last. At the same time, ECB President Christine Lagarde acknowledged that market turmoil might contribute to the central bank's tightening efforts.


US Rate Cuts Anticipated Before European Easing

Investors are optimistic about US government bonds due to the expectation that US rate cuts will occur before any easing in Europe. Two-year Treasury yields have fallen 92 basis points this month, compared to a 60 basis-point drop in Germany. Gerard Fitzpatrick, head of fixed income at Russell Investments, predicts that rate cuts by the end of the year will positively impact the US bond market.

European Stocks Favored Over US Equities

ClearBridge strategist Jeffrey Schluze stated that European banking regulation has been more stringent than in the US since the global financial crisis, creating a relatively strong outlook for European lenders. Investors are currently more overweight on European stocks relative to US peers than they have been since October 2017.

Changing Market Dynamics Amid Banking Turmoil

Before the banking turmoil, markets were primarily driven by one-way moves as high inflation impacted both US and European markets. The US dollar, which jumped 2.8% against six major peers in February, has since lost 2.7% in March. Emerging economy currencies are now rebounding, with the South African rand and Mexico's peso experiencing gains against the dollar. This shift suggests that markets will experience more cross-market volatility as investors focus.