Investors may be underpricing how far rate hikes could go, Deutsche says

Investing.com -- Deutsche Bank warned in a note Monday that investors may be underestimating how far interest rates could rise, as the world enters a synchronized tightening cycle.

Macro strategist Henry Allen highlighted that the Federal Reserve, European Central Bank and Bank of Japan have all hiked in the past two weeks, and while markets are pricing more to come, there are credible reasons to expect an even larger scale of tightening.

He pointed first to commodity prices, noting Brent crude around $100 a barrel and gains across the complex that are not yet reflected in inflation data or surveys, with energy shocks prone to second-round effects.

Allen also said central banks tend to overcorrect for the last crisis and are already reacting more hawkishly than in 2022, when they did not hike until inflation topped 8%. He noted Fed Chair Kevin Warsh has acknowledged that "for more than five years, inflation has been running above target."

Financial conditions are also more accommodative than at the start of the last cycle, he said, with the S&P 500 near record highs and credit spreads tighter, meaning more hikes may be needed to bring inflation down.

Crucially, Allen stated that history shows "markets tend to underestimate, rather than overestimate the extent of hiking cycles," noting that in 2022 investors initially priced 200 basis points of Fed hikes in the first year when more than 400 were delivered.

Still, he said strong growth means rate hikes need not derail equities, citing 1999, when the Fed hiked, yields rose and the S&P 500 still gained nearly 20%.

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