US Stock Markets Defy Rate Hike Expectations Amid War Uncertainty

US stock markets are hitting new highs despite the ongoing war, while oil prices and interest rate expectations remain elevated. This disconnect has led to four key aspects of central bank policy that appear difficult to square with market views.

The first discrepancy lies in the shift towards higher interest rates, with investors now expecting more tightening than easing. The spread between US and eurozone interest rates has widened, despite initial concerns over a more severe inflation shock in Europe.

This change is attributed to strong US economic data, which has led to a weakening case for near-term rate cuts. Additionally, the Federal Reserve has made efforts to talk up market rate expectations, with several officials keen to ditch the easing bias.

The second point of contention revolves around the UK repricing, where interest rates are now seen higher than before the war, around 40bp more than initial expectations. However, this seems misplaced given the current gas price situation and the UK's reliance on natural gas for energy.

The third discrepancy concerns the Bank of England's likelihood to deliver two rate hikes compared to the ECB. Despite both central banks taking different approaches, markets are pricing a similar amount of tightening in both economies.

Finally, investors appear to be overplaying the energy channel, with market expectations for the ECB and BoE still closely tied to oil prices rather than natural gas prices. This may not accurately reflect central banks' sensitivities, particularly given the current low natural gas prices.