Global central bankers are turning to tighter monetary policy, while indicating they will take longer and follow different paths than investors currently expect.
With inflation rising and growth slowing, most policymakers in developed economies are faced with a balancing act in which the risks are almost evenly split between acting too fast or too slowly. This increases the chances of surprising the markets and making a policy error.
Global bonds rallied this week as bets on the rate hike that caused a sell-off in October collapsed. US 10-year yields fell 8 basis points to 1.53% on Thursday, the biggest drop since August, while the Australian three-year yield saw the biggest drop in a decade, wiping out part of the last week’s peak which was the strongest since 2001.
The result is that officials are likely to move forward cautiously and at varying speeds, despite investor pressure for a quicker end of the easy money with bets the Bank of England (BOE) will raise in February, the Fed in June. and even that the European Central Bank will be reversed. its accommodating stance at some point in 2022.
“We are entering perhaps the most interesting phase of global monetary policy in living memory, which is if you are under the age of 50 or so,” said Chris Marsh, senior advisor at Exante Data LLC. .
While those who witnessed the 2008 financial crisis and the fallout from last year’s pandemic may disagree with this view, economists at JPMorgan Chase & Co. estimate that from here By the end of the year, about half of the 31 central banks they track will have lifted their benchmarks from the latest lows of the year.
At the root of most of the changes, inflation is proving to be broader and more persistent than expected, as post-lockdown demand, frayed supply chains, tightening labor markets and soaring costs of businesses. commodities drive prices higher and potentially longer.
The demise of these forces, as most central bankers still expect, will ultimately determine what happens next.
All policymakers will want to avoid the famous ECB mistakes in 2008 and 2011 when rates were raised only to evaporate the inflation threat and stifle growth.
Some, including the Fed, will also want to test new strategies on the road to allow inflation to rise higher than historically in order to cement the resumption of growth and hiring.
Powell, who isn’t even sure whether he has a job himself in February, said on Wednesday that “the inflation we’re seeing is really not due to a tight labor market.”
The opposite risk is that if central banks wait too long and inflation does not ease, business and consumer expectations could take hold, creating a price spiral that is harder to control and threatens to disrupt markets. .
Some emerging markets, including Brazil and Russia, are already aggressively tightening their policies in the face of accelerating prices. Norway, South Korea and New Zealand have also started to increase their rates.
The economists’ bet is that most central bankers will act with caution. JPMorgan Chase predicts that global policy rates will end next year about three-quarters of a percentage point below their 2019 average.
“Central banks are divided over inflation risks,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore Ltd. “So we think the bond markets have already forecast too many hikes in 2022.”
At Nomura Holdings Inc., economists led by Rob Subbaraman also say increases will be more limited than in previous cycles as the pandemic has left scars that will limit the rate of growth of economies before triggering inflation.
They predict that average global growth will be around 2.5% over the next decade, compared to 2.8% in the post-financial crisis years and 3.4% before 2008.
“Central banks will not need to aggressively raise rates to tighten financial conditions in order to control inflation or ease pressures on the economy,” Nomura economists said in a report. “The so-called terminal rate will likely be lower than in previous cycles.”
Krishna Guha, head of central bank strategy at Evercore ISI, is not so sure. He suggests that the Fed will stay on hold until December 2022, but then move a little faster, a little further.
Even though some are tightening, Berenberg Bank economists predict an “unsynchronized normalization of monetary policy” as central banks tend to rise at their own pace even though they simultaneously subside when shocks like Covid-19 knock.
Already ECB President Christine Lagarde is pushing back market bets on rate hikes in 2022, saying this week that their conditions are highly unlikely to be met next year.
This echoed RBA Governor Philip Lowe, who said he was “in trouble with the scenario that rates should be hiked next year.”
Japan’s new government and central bank confirmed this week that they will continue to cooperate to achieve inflation of 2%, a strategy that will temper market speculation on any early stimulus release in that country.
Even BOE Governor Andrew Bailey told Bloomberg the pricing is currently “a bit of a stretch.”
Minds can change quickly though. The Fed declined earlier than spectators expected earlier this year. As late as the end of September, Bailey said the UK economy was facing “tough courage.”
“It will be very difficult for the Bank of England, as well as other major central banks, to organize a smooth transition from the extraordinary monetary policies that we have seen during the pandemic period,” Katharine said. Neiss, Chief European Economist at PGIM Fixed Income. Bloomberg News