The US and UK Central Banks may raise interest rates by 75 basis points this week, but the implications are very different.

Last week, the US and UK bond markets showed a positive trend. US bonds rebounded, ending a continuous twelve-week decline, while UK bonds strengthened for two consecutive weeks.

The market widely expects that the Federal Reserve and the Bank of England will announce an increase of 75 basis points at this week's monetary policy meetings.

same magnitude, different meanings

Although the rate hike is the same, it means completely different situations for the Federal Reserve and the Bank of England:

For the Federal Reserve, four consecutive 75 basis point rate hikes will present a critical choice: the post-pandemic economic recovery is gradually being overshadowed by the negative effects of its tightening policies, while domestic inflation remains at its highest level in 40 years.

The Federal Reserve will have to choose between curbing inflation and avoiding economic recession, with the market expecting it to lean more towards the latter.

For the Bank of England, a 75 basis point interest rate hike will be the largest increase in borrowing costs since 1989. Clearly, the Bank of England is more inclined towards the former in curbing inflation and economic recession.

The stability of the political situation in the UK has temporarily restored calm to the government bond market, while the Central Bank of the UK will focus on tackling the most severe inflation problem in 40 years.

Will the Federal Reserve slow down its pace after the rate hike in November?

The rise in U.S. Treasury yields has caused the benchmark 10-year yield to fall to around 4%. Some investors believe that the Federal Reserve's earlier tightening policies may lead to an economic recession. Due to this concern, the Federal Reserve may slow the pace of interest rate hikes in the future, and the decline in the bond market may come to an end.

This view has received support from some officials at the Federal Reserve. A dovish official stated that the Federal Reserve should avoid excessively aggressive rate hikes that could lead to an "active slowdown" in the economy, and it is now time to discuss slowing the pace of rate increases.

Another official also publicly stated that if the peak federal funds rate next year exceeds the 4.6% level predicted by officials in September, the economy will face significant "non-linear" risks.

Despite the growing concerns of recession, inflation in the United States remains high, and the Federal Reserve has a long way to go in combating inflation.

Although the overall PCE price index slowed for the third consecutive month in September, the core PCE price index accelerated for two consecutive months. In addition, the consumer confidence index rose to a six-month high in October, with both short-term and long-term inflation expectations of consumers increasing compared to September.

Investors have largely digested the expectation of a 75 basis point rate hike in November, but there are still differences regarding the magnitude of the rate hike in December. Futures traders believe that the Federal Reserve will raise rates by another 75 basis points in December. A senior portfolio manager stated:

"The Federal Reserve will definitely raise interest rates by 75 basis points in November, but remains cautious about the rate decision in December, as there are two CPI reports before that meeting. They hope to break away from the monotonous pattern of 75 basis points, but will only slow down the rate of increases when inflation data starts to decline."

At the same time, the market's expectation for the Federal Reserve to signal a slowdown in interest rate hikes is heating up, and the significant drop in the 10-year Treasury yield last week reflects this expectation.

Investors expect economic growth to slow significantly, and the Federal Reserve will start cutting interest rates next year. As a result, investors have begun to increase their holdings of long-term government bonds. Recent surveys show that investors have returned to a net long position for the first time since 2021, at 100.1%, while another survey indicates that net long holdings have risen to their highest level in two years.

The Bank of England may raise interest rates by the largest margin in 33 years to combat inflation.

The fiscal plan originally scheduled for October 31 has been postponed for two weeks, complicating the Bank of England's rate-setting meeting this week, during which the bank will announce its interest rate decision and economic forecasts without knowledge of the fiscal details.

The market generally expects that the Bank of England may announce a 75 basis point interest rate hike this week, which would be the largest increase in borrowing costs since 1989.

Compared to the Federal Reserve, the Bank of England's situation is more challenging.

Firstly, there is stubborn inflation. The inflation rate in the UK reached 10% in September, returning to a 40-year high. The Bank of England previously warned that to alleviate the soaring cost of living, the interest rate hike in November may need to be higher than previously expected. The new Prime Minister also stated that "addressing the inflation issue will be the current focus of policy."

Secondly, there is an imminent recession. The Bank of England previously released a pessimistic outlook, predicting that the UK economy will fall into recession in the last three months of this year and continue until the end of 2023. Analysts are even more pessimistic, believing that the UK may have already entered a recession that could last until 2024.

In this round of interest rate hikes, although the Bank of England was one of the first central banks to raise interest rates, the magnitude of the hikes has lagged behind that of the Federal Reserve and the European Central Bank. With the Federal Reserve having raised rates by 75 basis points three times in a row, and the European Central Bank also raising rates by 75 basis points all at once last week, the situation for the Bank of England has become even more precarious.

In addition, the former prime minister's radical tax cut plan had led the UK bond market into crisis, and the UK government also needs to rebuild its damaged credibility.

With the change of Prime Minister in the UK, the British bond market has gained a brief calm, having risen sharply for two consecutive weeks as of this week.

An economist commented: "As the root cause of the political chaos is eliminated, the risk premium on UK assets gradually decreases, and the pressure on the Bank of England to take aggressive action has eased."