Global Central Banks May Launch 2026 Rate Hike Race as Fed Pivots to Easing Against the Tide

TradingKey - By late 2025, global monetary policy is unfolding a rare reverse script. While the Federal Reserve is on the verge of its third rate cut this year and poised for further easing in 2026, major economies including Europe, Australia, and Japan are signaling rate hikes.

The Federal Reserve is highly likely to cut the federal funds rate by another 25 basis points tonight, marking the sixth reduction in this easing cycle.

Markets anticipate this move, given persistent signs of U.S. economic weakness. The unemployment rate climbed to a two-year high of 4.1% in October, non-farm payrolls have fallen below 150,000 for three consecutive months, and the manufacturing PMI has languished in contraction territory for 13 months. Although the core PCE price index remains elevated at 2.8%, its four-month declining trend has opened a sufficient window for accommodative policy.

With the 2026 U.S. midterm elections coinciding with the nation's 250th anniversary, the Trump administration desperately needs positive economic news to endorse its policies and has relentlessly pressured the Fed.

Kevin Hassett, a leading candidate for Fed Chair, has explicitly called for "aggressive rate cuts." If he assumes office, the federal funds rate could be pushed down to the 2.0%-2.5% range.

Institutional forecasts are aligning with this view. Goldman Sachs expects at least two more rate cuts in 2026, bringing the rate to 3%-3.25%. PGIM is even more aggressive, suggesting the Fed might resume balance sheet expansion as early as January next year to stabilize short-term rate volatility.

Global Central Banks' Hawkish Contingent

In stark contrast to the Fed, an increasingly hawkish chorus is emerging among global central banks.

The European Central Bank (ECB) has been compelled to adopt a tougher stance due to sticky inflation.The Eurozone's harmonized CPI rose 2.2% year-on-year in November, still above the 2% policy target, while the services PMI reached a two-and-a-half-year high. This economic resilience supports rate hike expectations.

ECB official Isabel Schnabel directly stated that "higher borrowing costs are reasonable," a comment that quickly prompted market repricing, with swap pricing now indicating a higher probability of rate hikes than cuts next year.

Although the Bank of England is expected to cut rates by 25 basis points at its meeting next week, the OECD believes its easing will cease in the "first half of 2026," with rates approaching a neutral level that neither stimulates nor constrains the economy.

Reserve Bank of Australia Governor Michele Bullock on Tuesday explicitly ruled out further easing, with the swaps market pricing in nearly two rate hikes next year. Meanwhile, Canada's robust November jobs data has led traders to bet on a potential rate hike as early as next year.

The Bank of Japan (BOJ), previously a dovish outlier, will continue tightening policy next year, with two rate hikes expected before year-end as it gradually exits its decades-long ultra-loose cycle.

Proactive Divergence

Looking back at global monetary policy cycles since the 1990s, "long-term convergence with periodic divergence" has been the norm. However, the current divergence exhibits unique characteristics.

Past divergences were often driven by external crises — Canada was forced to raise rates in 1994 during the Mexican peso crisis to curb capital flight, and the 2015 oil price collapse led to rate cuts in Canada while the Fed hiked. These were passive responses to external shocks.

In contrast, the current divergence is a result of proactive choices by individual countries. The Fed is proactively easing to counter an economic slowdown, while Europe, Japan, and others are proactively tightening to guard against inflation and debt risks.

Crucially, the scope of impact is unprecedentedly broad. After the global financial crisis, rate hikes in non-U.S. economies typically began with resource-rich nations before spreading to manufacturing countries. However, with developed economies collectively shifting towards rate hikes and directly opposing the Fed, the impact on global capital flows will be far more intense.

Structural Opportunities and Risks Loom for Equity, Bond, and FX Markets

Jim Reid, Global Head of Macro Research at Deutsche Bank, warns: "It's striking how many regions now see a rate hike as the next move. If that were also to happen in the U.S., there's no question that both risk assets and the economic outlook for next year would change dramatically."

The market impact of policy divergence is already becoming apparent. ING analyst Chris Turner predicts that if the Fed maintains its dovish stance, the shift in overseas policies will be a key factor for a slightly weaker dollar in 2026. The dollar has already fallen over 8% against a basket of currencies this year.

Meanwhile, currencies of hiking countries like the Euro and Australian dollar are poised to be major beneficiaries, while emerging market currencies will find some breathing room, and the Yuan exchange rate will benefit from the narrowing China-U.S. interest rate differential.

A trend of rising long-term bond yields globally may emerge. Global term premiums are being re-established amidst strengthening nominal economic growth and ample bond supply in Europe and Japan.

Technology stocks may temporarily benefit from Fed easing, but valuation pressures are looming. Goldman Sachs raised its year-end S&P 500 target to 6600 points, but highly valued tech stocks could face a pullback if global liquidity contracts more than expected.

Commodities and cryptocurrencies are under pressure as liquidity recedes. Unwinds of yen carry trades have already led to $3.45 billion in outflows from Bitcoin ETFs in a single month, and next year's global liquidity divergence could exacerbate volatility in these asset classes.