Singing from the same hymn sheet
In the run up to last week’s Jackson Hole conference of central bankers in Wyoming, there had been considerable speculation about what Fed Chair Jerome Powell might say. The balance of opinion was that he would be forceful, and bond yields moved higher accordingly. In the event he was very direct in his statements, and bond yields moved even higher.
It is worth quoting a few of his remarks. “Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labour market conditions. While higher interest rates, slower growth, and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain”.
This view was reinforced by other Governors. For example, New York Fed President John Williams said the Fed will need to lift its policy rate “somewhat above” 3.5% and keep it there through the end of 2023. “We’re going to need to have restrictive policy for some time. This is not something that we’re going to do for a very short period of time and then change course; it’s really about getting policies to the right place to get inflation down and keeping it in this position”. Cleveland Fed President Loretta Mester made similar comments.
The Fed was not alone in being hawkish. At Jackson Hole, ECB member Isabel Schnabel gave a very hawkish speech, calling for aggressive hiking of interest rates in order to prevent inflation expectations from de-anchoring or a price-wage spiral from kicking in. ‘Caution’, Schnabel said, was the wrong medicine to deal with the current supply shocks. Instead, she called for a ‘forceful’ response even at the risk of lower growth and higher unemployment. Bundesbank President Nagel similarly demanded a “strong” ECB rate hike. The view is growing that the policy rate needs to move more quickly above its neutral level.
European inflation data added to such concerns. Headline CPI across the Eurozone was confirmed at a new high of 9.1% a year; indeed German inflation was its fastest for 52 years. Together with further falls in the Euro versus the US dollar, it is also little surprise that the financial markets are actively considering that the ECB might act by 0.75% rather than 0.5% at its September meeting.
Inflation data in other countries added to the sense that central banks remain under pressure to act. In the UK, following the announcement on the energy price cap, Goldman Sachs has warned that headline inflation might reach 22% in January, depending of course on decisions by the new Prime Minister. The Bank will also take note that its own panel of chief financial officers at UK businesses expect CPI to 8.4% in a years’ time, and 4.2% in 3 years’ time, still above the central bank target.
The end result has been a further move higher in bond yields across the yield curve in most of the major economies. The UK 2 year yield has reached 3.1%, which is about 2% higher than its position six months ago. In effect, markets have priced in both a more aggressive move by central banks in September or the autumn, and keeping rates higher for longer into 2023.
G7 central bankers all seem happy with the following words from Powell “We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done”. Financial markets are listening and reacting.
Bond yields at the time of writing this week
% 2 year 5 year 10 year
USA 3.50 3.40 3.26
UK 3.08 2.85 2.92
Germany 1.20 1.38 1.57
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