Munix Weekly 27 May 2022
“Row, row, row the boat merrily down the stream”
Central bankers are constantly speaking to an array of different audiences, such as households and businesses, politicians and the media. Sometimes, the members of a policy committee will row together in the same direction, on other occasions the rowers work against each other, or even try to change the direction of the boat.
There was a stream of central bank speeches and statements this week. ECB members were out in force making it abundantly clear that interest rates would rise in July and probably September as well, its first increases since 2011. The only debate is whether the first move will be 0.25% or (less likely) 0.5%, Christine Lagarde was a model of clarity when she said that “based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter”.
The Federal Reserve still has an ongoing debate between the hawks and the doves. On the one hand, Bullard is looking for rates to reach 3.5% by year end, on the other hand Bostic commented that a pause in rate hikes as early as September might make sense, to ascertain the impact of the policy tightening. This represented the first hint in a dovish direction from the Fed in several months.
The doves can point to plenty of soft indicators and surveys pointing to a slowdown in the economy. Higher mortgage rates are working; new home sales are their lowest for two years. The Conference Board CEO confidence index is approaching recessionary territory, although actual capital spending and hiring is holding up better. See what they do, not what they say, is a good motto for any investor.
The hawks can point to inflation risks. Minutes from the Fed’s last meeting confirmed that interest rates are on course to rise by 0.5% in both June and July as a return towards more neutral levels. This leaves the door open for a more restrictive stance if needed to curb inflation pressures. After all, the Fed has been forced to raise its inflation forecast yet again, admitting it will still be above 4% at the end of this year. Goldman Sachs estimates that wage growth needs to slow from its current 5.5% pace to about 3.5-4% in order to be compatible with the FOMC’s 2% inflation target.
In the UK, Andrew Bailey joined in the discussion. Defending himself from the considerable criticism last week, when he admitted the Bank had limited options to tackle inflation, this week he argued that high energy prices would do much of the work to depress consumer spending, allowing the central bank to take a less aggressive approach to raising interest rates. Silvana Tenreyo and Huw Pil both explored the tricky balancing act which the Bank faces; more interest rate rises would be needed to quell inflation pressures, but the central bank needed to guard against the current economic slowdown turning into a recession. After all, the service sector purchasing managers index has fallen as low as 51.8 in April, just above the 50 boom-bust level. The MPC’s problems have been exacerbated by the Chancellor’s announcement of a £15 billion fiscal stimulus to address the cost of living crisis, on top of March’s £22bn spending package. Conversely, the government increased its tax take again, taking it to the highest level since the early 1950s. Working out the economic impact will not be easy.
Financial markets spend much time trying to interpret the nuances of what is being said, paying particular attention to any new signals. European yields edged higher in line with the uniformity of views amongst ECB members. Conversely, US yields edged lower as markets paid more attention to the differences of views amongst Fed officials and evidence of a deceleration in the economy. In contrast, the Bank of England is caught between a rock and a hard place – it cannot address many of the external drivers of inflation, wage awards are not in line with inflation targets, but government policy is trying to prevent too rapid an economic slowdown. Not surprisingly, gilt yields have been little changed whilst investors try to decide which side of the row boat will win out in the competition to point it in the right direction.
The big picture is that all three markets think central bankers have done enough for the time being – as the table shows benchmark yields have not decisively broken 3%, 2%, or 1% ceilings. The danger is that central bankers have proven rather reactive rather than proactive to recent events, and unpleasant news from China, Russia, Ukraine or elsewhere could easily swamp the boat.
Central banks’ policy tightening
Bond yields at the time of writing this week and one month change
% 2 year 5 year 10 year
USA 2.46 (-0.13) 2.71 (-0.11) 2.75 (-0.07)
UK 1.45 (+0.02) 1.61 (+0.03) 1.99 (+0.16)
Germany 0.35 (+0.23) 0.67 (+0.13) 0.99 (+0.17)
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making