The word from three central bank heads
Was something that each of them dreads
Is failing to let
Their nations, thus tightening spreads
Instead, each one promised that they
Won’t tighten till some future day
When ‘flation is soaring
And folks are imploring
They stop prices running away
As we come to the end of the week, on a Friday the 13th no less, investors continue to be encouraged by the central bank community. Yesterday, at an ECB sponsored forum, the heads of the three major central banks, Fed Chairman Jerome Powell, ECB President Christine Lagarde and BOE Governor Andrew Bailey, all explained that their greatest fear was that the second wave of Covid would force extended shutdowns across their economies and more permanent scarring as unemployment rose and the skills of those who couldn’t find a job diminished. The upshot was that all three essentially committed to displaying patience with regard to tightening policy at such time in the future as inflation starts to return. In other words, measured inflation will need to be really jumping before any of these three, and by extension most other central bankers, will consider a change in the current policy stance.
Forgetting for a moment, the fact that this means support for asset prices will remain a permanent feature, let us consider the pros and cons of this policy stance. On the one hand, especially given the central banking community’s woeful forecasting record, waiting for confirmation of a condition before responding means they are far less likely to inadvertently stifle a recovery. On the other hand, this means central banks are promising to become completely reactive, waiting for the whites of inflation’s eyes, as it were, and therefore will be sacrificing their ability to manage expectations. In essence, it almost seems like they are dismantling one of the major tools in their toolkits, forward guidance. Or perhaps, they are not dismantling it, but rather they are changing its nature.
Currently, forward guidance consists of their comments/promises of policy maintenance for an uncertain, but extended period of time. For instance, the Fed’s forecasts indicate interest rates will remain at current levels through 2023. (Remember Powell’s comment, “we’re not even thinking about thinking about raising rates.”) But what if inflation were to start to rise significantly before then? Does the current guidance preclude them from raising rates sooner? That is unclear, and I would hope not, but broken promises by central banks are also not good policy. However, if the new forward guidance is metric based, for instance, we won’t adjust policy until inflation is firmly above 2.0% for a period of time, then all they can do is sit back and watch the data, waiting for the economy to reach those milestones, before acting. The problem for them here is that inflation has a way of getting out of hand and could require quite severe policy medicine to tame it. Remember what it took for Paul Volcker as Fed Chair back in the early 1980’s.
My observation is that, as with the initiation of forward guidance, this is a policy that is much easier to start than to unwind, and either it will become a permanent feature of monetary policy (a distinct possibility) or the unfortunate soul who is Fed Chair when it needs to be altered will be roasted alive. In the meantime, what we know is that central banks around the world are extremely unlikely to tighten policy for many years to come. We have heard that from the BOJ, the RBA, and the RBNZ as well as the big three. All told, one could make the case that interest rates have found their new, permanent level.
And with that in mind, let us tour market activity this Friday morning. Equities in Asia followed from Wall Street’s disappointing performance yesterday and all sold off. The Nikkei (-0.5%) fell for only the second time in the past two weeks. Meanwhile, after President Trump signed an executive order preventing US investors from supporting companies owned or controlled by the PLA (China’s armed forces), equities in HK (Hang Seng -0.1%) and Shanghai (-0.9%) both fell as well. The story in Europe is less clear, with some modest strength (DAX +0.2%), CAC (+0.3%) but also some weakness (FTSE -0.5%). I would blame the latter on further disruption in the UK government (resignation of a high ranking minister, Dominic cummings) and a fading hope on a Brexit deal, but then the pound is higher, so that doesn’t seem right either.
Bond markets, which all rallied sharply yesterday, are continuing that price action, albeit at a more modest pace, with all European markets showing yield declines of between one and two basis points, although Treasuries are essentially unchanged right now. Of course, Treasuries had the biggest rally yesterday.
Oil is softer (WTI – 1.0%) and gold is a touch firmer (+0.2%) although the latter seems clearly to have found significant support a bit lower than here. As to the dollar, on the whole it is softer, but not terribly so. For instance, GBP (+0.3%) is the leading gainer, with AUD (+0.2%) next on the list, but those are hardly impressive moves. While the bulk of this bloc are firmer, SEK (-0.4%) has fallen on what appears to be a combination of position adjustments and bets on the future direction of the NOKSEK cross. As to the EMG bloc, there are more gainers than losers, but MXN (+0.3%) is the biggest positive mover, which seems to be a hangover from Banxico’s surprise decision yesterday afternoon, to leave the overnight rate at 4.25% while the market was anticipating a 25-basis point reduction. On the downside, CLP (-0.95%) is the worst performer, as investors appear concerned that there will be further financial policy adjustments that hinder the long-term opportunity in the country.
On the data front, overnight we saw Eurozone Q3 GDP released at 12.6% Q/Q (-4.4% Y/Y), a tick worse than expectations but it is hard to imply that had an impact of any sort on the markets. In the US, yesterday saw a modestly better outcome in Initial Claims, and CPI was actually 0.1% softer than expected (helping the bond rally). This morning brings PPI (exp 0.4%, 1.2% Y/Y), about which nobody cares given we have seen CPI already, and then Michigan Sentiment (82.0) at 10:00. We have two Fed speakers on the docket, Williams early, and then James Bullard. But given the unanimity of the last vote, and the fact that we just heard from Chairman Powell, it would be a huge surprise to hear something new from either of them.
So, as we head into the weekend, with the dollar having been strong all week, a little further softness would not be a big surprise. However, there is no reason to believe that there will be a significant move in either direction before we log off for the weekend.
Good luck, good weekend and stay safe