IT'S IN OCTOBER; Deutsche Bank believes the market is mistaken and anticipates a cascade of rate hikes in Europe and the US:

Deutsche Bank warns that markets underestimate the magnitude of impending interest rate hikes, citing historical patterns where central banks tend to be more aggressive than anticipated.

The market appears to be making a common mistake: underestimating how far interest rates will have to rise. **Deutsche Bank** believes investors are underestimating the magnitude of the impending monetary tightening, and history supports this view. The German bank points out that central banks are often more aggressive in the final battle against inflation, and markets tend to underestimate, rather than overestimate, the scale of these cycles.

## Inflation and History: Deutsche Bank's Arguments

One significant reason for this view is that current inflation has not yet fully absorbed the latest energy shock caused by the war in **Iran**. Brent oil prices are around **102 dollars**, and the Bloomberg commodities index is above levels recorded between June and August. However, recent Consumer Price Index (CPI) data and available surveys only go up to August, meaning they have not yet incorporated this new inflationary impulse. **Deutsche Bank** recalls that the longer an energy shock persists, the greater the risk of second-round effects, as virtually all industries use energy and eventually pass on some of the increased costs to other goods and services. Even before the latest spike, the paid prices component of the ISM services index was at levels compatible with US inflation exceeding **5%** in previous cycles.

A second, less obvious but perhaps more important reason exists. Central banks tend to be much more aggressive in the "final battle" against inflation. **Deutsche Bank** detects a historical tendency among monetary authorities to correct, and occasionally overreact, to errors made during the previous crisis. After the first oil shock in **1973**, the response to the second one in **1979** was much more aggressive because there was a feeling that too little had been done. In **2020**, the opposite occurred: central banks reacted immediately to the pandemic with enormous stimulus, after considering the initial response to the 2008 financial crisis to be excessively timid.

The memory that weighs heavily is from **2021-2023**, when the **Federal Reserve** and the **ECB** were late to inflation that they initially labeled as transitory, ultimately being forced to raise rates much more violently. In **2022**, they did not begin acting until CPI had already exceeded **8%** in both the **US** and the Eurozone. This time, they started tightening monetary policy when inflation was less than half that amount.

## The Strength of Markets: A Double-Edged Sword

The third argument from **Deutsche Bank** is perhaps the most curious. The very strength of markets can ultimately lead to further rate hikes. When the **Fed** began tightening policy in **2022**, the **S&P 500** had already corrected by more than **10%**. Now, it is less than **2%** from its all-time highs. Something similar happens with credit. US high-yield bond spreads were over **400 basis points** then and are around **270** today; in Europe, they approached **600 basis points** when the **ECB** began hiking rates in July **2022**, and currently do not reach half that amount.

A stock market crash, a sharp increase in risk premiums, or credit tightening are part of the central banks' work to cool down the economy. If none of this happens, **Deutsche Bank** warns, rates must do more work, and under equal conditions, the necessary monetary tightening must be greater.

History shows how wrong the market can be about calculating that tipping point. In **2022**, when the **Fed** began hikes, futures discounted about **200 basis points** of tightening during the first year; it ended up being more than **400 basis points**. The error was not only in the total magnitude but also in the estimulante ilegal: the **Fed** started with moves of **25 basis points**, accelerated to **50**, and finished with even larger steps.
The **ECB** played virtually the same history. The market expected about **200 basis points** during the first year, and **Frankfurt** ended up executing **400 basis points**.

One explanation is that monetary policy operates with a lag: initial hikes do not immediately produce the desired cooling, which creates pressure to continue tightening while new inflationary shocks or second-round effects may emerge.

This was not an anomaly of the post-pandemic great inflation crisis. When **Alan Greenspan** began raising rates in **2004**, the **Fed** itself assured that unwinding stimulus could be done at a "probably gradual" pace. The market discounted about **200 basis points** of hikes over the trinc two years, but the **Fed** ended up raising the price of money in **17** consecutive meetings and accumulated more than **400 basis points**. Something similar peine between **1999** and **2000**. After three preventive cuts due to the Russian financial crisis, investors thought the **Fed** would simply reverse those cuts, but the central bank went much further and ended up tightening by **175 basis points**.

The **1994** episode is similar and also serves as a warning to the current bond market. When that cycle began, futures anticipated approximately **140 basis points** of hikes through Christmas. The **Fed** ended up executing **250 basis points** in that timeframe and **300** during the entire first year. The consequence was a carnage in fixed income, with the yield on the ten-year US Treasury bond rising **208 basis points** in **1994**, its largest increase since **1980** and the era of **Paul Volcker**. A move that would not be repeated with such intensity until **2022**.

The message from **Deutsche Bank** is that the pattern repeats itself because it is extraordinarily difficult to predict a monetary inflection point after years or months of stable or falling rates.

Nevertheless, the resilience of the **S&P 500** and European markets, far from proving that discounted hikes are sufficient, may be one of the reasons why they ultimately have to be larger. A stock market near highs, contained credit spreads, and a growing economy keep financial conditions relaxed, sustain demand, and allow central banks to continue tightening without immediately causing a recession.

**Deutsche Bank** believes that the resilience of growth since the beginning of the conflict with **Iran** is precisely what is providing central banks the space to raise rates relatively agilely without causing an economic earthquake. The market bets today on more than **100 basis points** of tightening from the **Fed** and more than **125** from the **ECB**. The history compiled by the German bank warns that investors' recurring mistake has not been antiestéticaring too many hikes, but discovering too late that there were still many more to come.