(Bloomberg) -- Investors should brace for jumbo rate hikes from the European Central Bank at its next two meetings and place their bets to take account of that possibility, according to Citigroup Inc.
Antoine Gaveau, a fixed-income strategist at Citi, recommended deploying interest-rate swaps tied to the ECB's October meeting as a way to position for two three-quarter point rate increases this month and next.
Money markets have placed 70% odds on a 75 basis-point increase when the central bank meets next week, as policy makers turn more hawkish amid calls for more aggressive steps to bring rampant inflation in the euro area to heel. A hike of such magnitude next week could usher in a similarly-sized increase at the ECB's meeting in October, Gaveau wrote in a research note.
“In our view, a fast (but potentially short) tightening cycle is a compelling baseline,” he wrote. “Hawks have won pretty much every argument over the past few months.”
Hikes beyond end-2022 look “very uncertain,” Gaveau wrote. That's because the ECB may not have to keep tightening the monetary screws if demand gets crushed fast enough and supply-side tensions abate.
In recent days, a growing number of policy makers have called for hike of more than than half a point at the policy meeting concluding on Sept. 8. The deposit rate currently stands at 0%.
Economists at BNP Paribas also expect “a more front-loaded tightening cycle” driving the terminal rate to 2% by the end of the first quarter.
A Bloomberg survey of economists predicts a 75 basis-point hike next week. Meanwhile, money markets are wagering on a combined 125 basis points of hikes over the next two meetings.
Here's the advice from the Citi strategists on how to position for the next ECB meetings:
- Pay October ECB ESTR at 1.157% to target 1.419% with a stop at 1.026%
- Sees ECB hawks' push for a 75bps hike at one of the next two meetings “as a floor”
- “We like to position for the possibility of two 75bp hikes by paying October 2022 ECB €STR”
- Risks to the trade include a 50bps hike and/or a deteriorating macro backdrop
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