Among the avalanche of 2026 outlooks that banks have sent to their clients in recent weeks, few contain the possibility that global interest rates could trend up, rather than fall or stay the same. Derivatives markets put the chance of tighter policy at the end of next year at 0% in the US and just 30% in Europe, even as some rate-setters sound increasingly hawkish. Recent policy shifts in Japan and Australia suggest investors should take the risk seriously.
Cries for tighter monetary policy are getting louder. On Wednesday, the Federal Reserve cut rates by 25 basis points and pencilled in one more reduction in 2026. Yet dissent is growing: six of the 19 officials who submitted forecasts wanted no cut and three expected rates to rise by the end of next year.
Outside of the US, the signals are even clearer: European Central Bank board member Isabel Schnabel recently suggested the next move will be a hike. This seemed unlikely when the ECB’s own projections showed inflation falling below target, but President Christine Lagarde said this week that the euro zone’s economic prospects will be revised up.
Investors aren't fully buying it yet. Bets on where rates will average over the next year have started to tick up in some major economies, but the moves are small and largely relate to pricing out further easing. In the US, most brokerages assume borrowing costs will fall another 50 basis points, as do traders.
One exception is Japan, where derivatives suggest a 75% probability of a rate hike this month. But it’s a unique situation: the Bank of Japan has barely tweaked its ultra-loose monetary policy since the pandemic and is now reacting to a large, inflationary fiscal expansion.
The most striking U-turn is in Australia, where markets have shifted from expecting cuts to believing policy will get much tighter at breakneck speed. With central banks often moving in lockstep, it could set a trend. Indeed, similar bets are starting to spread to Sweden and Canada, which have so far only signalled plans to stand pat.
Borrowing costs are still unlikely to rise enough to derail stocks next year. In many Western economies, unemployment is edging up, wage growth is cooling and inflation expectations remain anchored.
These are signs that policy isn’t overly loose. In the near term, though, central banks are under immense pressure: headline inflation is sticky and above target, growth is coming in stronger than expected, fiscal policy is stimulative in countries like Germany and housing markets are rebounding in places like Australia and Sweden. Even in the US, where the president is lobbying for easy money, the bar for a sudden hawkish pivot may be lower than investors think. A global increase in rates could be the hidden danger for markets. — Reuters
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