Rate cut bets melt as vaccines boost economy hopes

Expectations of interest rate cuts in some of the world's biggest economies have melted within the space of a month on hopes a successful coronavirus vaccine will fuel a growth bounceback next year.

As recently as October 20, markets were pricing rate cuts of up to 25 basis points from leading central banks by next autumn as the resurgent pandemic threatened a double-dip recession.

But encouraging updates on vaccines from Pfizer and Moderna have tempered that gloom, a mood reflected in a rise in long-dated government bond yields and a lower chance of rate cuts, according to Berenberg economist Florian Hense.

"The success of vaccine trials has been a game-changer – there's now a realistic possibility that a large share of the population of most advanced economies will receive a vaccine by mid-2021, which in turn will allow restrictions on activity and movement to be lifted and bring forward the economic recovery," said Neil Shearing, group chief economist at Capital Economics.

Between Nov. 5-9, a period when it became clear Democrat Joe Biden had won the US election and Pfizer announced its vaccine news, eurodollar futures, which track short-term US rate expectations, flipped to reflect expectations of 10 bps in rate hikes by Sept 2022.

Just the previous week, markets were predicting no changes. Futures now expect US rates at 0.50% by September 2023, from 0.25% forecast a month previously.

At the ECB where rates are already minus 0.5%, a nine bps cut was expected by September 2021 but that is now slashed to only five bps.

The biggest change is in the United Kingdom which has fared especially badly in the pandemic and could be one of the biggest beneficiaries from a vaccine.

Markets now expect a cumulative five bps in cuts from the Bank of England up to August 2021, down from 15 bps of reductions priced last month when the BOE looked likely to take borrowing costs negative by March.

Countries whose fortunes are more tied to China have also seen rate cut expectations fall as data indicated a strong recovery. The Reserve Bank of Australia is expected to cut rates by around 2 bps over the next year compared to nearly 6 bps last month.