(S)Quid Game – red light or green light for rate hikes?

It remains to be seen who can survive if we see higher policy rates.

When not sitting puzzling over the surreal Netflix series, Squid Game, the past week has seen market participants focus on the front end of rates curves. For years, the ‘red light’ for rate hikes has effectively locked front-end yields, but this week saw the market move to price a full UK rate hike – in just one day. This came after hawkish comments from Bank of England (BoE) Governor Bailey on Sunday, as he remarked that while monetary policy can’t solve supply bottlenecks, central banks must react anyway.

This left the market puzzling over the future path of monetary policy and concerned about potential 1970s style stagflation, especially in the UK where supply shortages and continued uncertainties around Brexit weigh on the growth outlook.

UK CPI printed slightly lower and below expectations this week, but this drop had been well flagged as driven by base effects, and we expect inflation to rise above 6% in months to come. However, it’s becoming increasingly clear that the UK isn’t the only economy that could see 6%+ inflation in months to come.

Both data and market pricing are coming closer to our long-held expectation that the supply shock has long-lasting repercussions for global supply chains.

With the market having already dealt with shortages in the energy sector, we are now seeing issues in other sectors such as autos, where demand for magnesium is currently challenged, resulting in far-reaching consequences for production.

With rising prices, sentiment indicators have stalled somewhat recently, but the consumer continues to spend, as highlighted by US retail sales last Friday showing 12% year-over-year growth and China retail sales outperforming expectations with a 16.4% annual run rate. This indicates that, for now, companies have the power to pass on higher prices to consumers, and so those prices are more likely to show up in inflation, rather than impacting corporate margins.

Indeed, earnings season has started well, pushing many stock indices towards new highs and supporting risk assets more generally. Having started the month under the cloud of Chinese real estate and the US debt ceiling, stocks now seem oblivious to negative news, ignoring the spike in Covid cases that looks to be bringing fresh restrictions in some countries.

Emerging markets

Emerging markets on the other hand continue to trade on the back foot, with several idiosyncratic stories in focus. In Turkey, the central bank cut the repo rate by 200bps to 16%, despite inflation running at close to 20% and with the risk that further currency weakness will push inflation even higher. This followed Erdogan firing several central bankers last week that were not aligned to his unorthodox monetary policy of cutting rates when inflation is rising.

Meanwhile, in Brazil, Bolsonaro seems to have escaped a charge of murder and genocide, but most likely the findings of a congressional inquiry will not help his popularity going into next year’s election and questions will continue to be asked around whether fiscal austerity is the right policy for an economy where growth is set to be one of the worst in the G20 next year.

China’s growth outlook also remains rather dim, although in the Evergrande ‘tug of war’ between domestic and foreign investors, it seems we got two winners with coupons having finally been paid. Despite the negative impact of the managed credit slowdown in China, the positives of robust exports and demand into a very slow economic reopening will most likely support the picture going forward, leaving the country in a less-levered position without falling into the global liquidity trap out of which other developed countries often struggle to escape.

Elsewhere, others are playing the game right. The bottlenecks in commodity supply have not only come from current freight disruptions, but also several years of underinvestment while oil prices were below 60 and additional costs from the push for a greener global economy. This is helping the current account dynamics of commodity exporters.

Terms of trades have improved significantly, even for Australia, where a slump in iron ore prices and an uncertain Chinese growth outlook cast doubts on the export growth outlook, but prices for coal and natural gas have more than offset the price decrease in iron ore. We expect this trade to continue and some of these countries are using the solid external demand backdrop to exit the interest rate policy at the lower bound.

We have already seen Norway and New Zealand lifting off and we expect them, in our base case, to continue hiking rates. The Norwegian trade balance data last Friday has risen to the highest data point for the last 40 years. The New Zealand quarterly CPI print came in this week at 4.9% – 0.7pp higher than expected and we anticipate it will climb closer to 6% in Q4 and Q1 next year.


Sticking with our Squid Game theme, the “sick old man” that is Europe will show its teeth next week when the ECB meet. The news on Wednesday that Jens Weidmann is leaving seems likely to move the ECB closer together. Potential successors such as Jörg Asmussen, former deputy finance minister from the social democratic party, Claudia M. Buch or Isabel Schnabel herself all seem more integrative and centrist.
ECB messaging this week from Lane and Villeroy lead us to believe that the ECB will push back on current market pricing, which has, somewhat ambitiously, priced out negative cash rates within the next two years.


Credit markets continue to recover after the recent bout of modest spread widening, but show no signs of trading outside of their relatively narrow range. CDS indices have seen a slightly bigger round trip in terms of spread moves. This appears to be where a lot of investors implemented short term hedges, which have subsequently been removed, thus driving levels back to where we were at the start of October.

As highlighted, earnings season is picking up and generally beating expectations, which is calming fears of supply-chain driven downside surprises this quarter. This also means primary market activity has been muted due to company blackouts. This in turn has made for a quieter credit market.

Looking ahead

We are still at the beginning of the market’s own Squid Game, and it remains to be seen who can survive if we do see higher policy rates going forward. A ‘green light’ to rate hikes has the potential to be quite painful for some sectors of the economy and not all governments will have the appropriate skills to manoeuvre their way through.

We continue to favour countries with a solid fundamental backdrop and orthodox policies, but central banks and governments must be very careful how they adjust to the next round. Some monetary tightening, such as in the UK, might end up too premature and the market will be fast to punish errors.

There are tricky games ahead – let’s hope it’s not a case of last man standing!

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