A Deliberation, or a Mystique, or a Sintra
Collective nouns are interesting – a flock of sheep, a pride of lions, a parliament of owls, a murder of crows. What should the collective noun be for a gathering of central bank governors? Perhaps a Deliberation, or a Mystique, or a Sintra – which refers to the town in Portugal where all the good and great gathered this week to explain their views on the state of the world and future risks.
There was much for fixed income markets to chew over. On balance the assorted governors warned of the dangers of allowing inflation to get out of control. The latest stern intervention from the central bank of central banks, the Bank for International Settlements, namely “Timely and decisive action by central banks is needed to restore low and stable inflation” appears to have had the desired effect. Christine Lagarde warned though that “I don’t think we are going to go back to that environment of low inflation. There are forces that have been unleashed… that we’re facing now that are going to change the picture and the landscape within which we operate. “Is there a risk we would go too far? Certainly there’s a risk,” Mr. Powell admitted. “The bigger mistake to make—let’s put it that way—would be to fail to restore price stability.” Bank of England governor Andrew Bailey conceded that the UK economy is “weakening rather earlier and somewhat more than others.”
It is not only central bank governors who are worried about how much economic growth will need to slow in order to restrain inflation. Survey after survey of economists and fund managers shows their concerns. In a June assessment of US macroeconomic experts conducted by The Financial Times and the University of Chicago, nearly 70 percent said a recession was likely in 2023.
As far as hard evidence is concerned, investors see ever more evidence of stagflation around the world. A series of European inflation reports for June showed a range from France at 5.8% and Germany at 7.6% through to Spanish inflation reaching 10.2% from a year ago. Business surveys from the Purchasing Managers organisations showed a further step down in global manufacturing and services sector activity to about 52 in June (between 45-50 and recession alarm bells start ringing).
All this talk of impending recession is having an impact on financial markets. Certainly a series of rate hikes are fully expected in the USA and UK and Europe into year end. However, markets are beginning to examine the possibility of rate cuts in these countries from mid-2023. This appears, for example, in the US 10-year bond yield falling back below 3%, threatening an inverted yield curve, while there was a noticeable fall in 2 year bond yields in Germany and a modest flattening of the whole yield curve in the UK.
There are risks to such views, of course. One danger is that bond investors pay too much attention to interest rate expectations and not enough to the other major change in monetary policy which is being seen, the aggressive shift from quantitative easing to tightening, which will increasingly affect demand and supply for government bonds. Further inflation from supply side shocks or militant workers successfully gaining large pay awards would certainly worry the next gathering of central bank governors, who convene again at Jackson Hole in America in August to discuss “”Reassessing Constraints on the Economy and Policy.”
Bond yields at the time of writing this week and one month change
% 2 year 5 year 10 year
USA 2.94 (+0.37) 3.02 (+0.20) 2.98 (+0.18)
UK 1.84 (+0.35) 1.89 (+0.28) 2.22 (+0.24)
Germany 0.63 (+0.18) 1.06 (+0.29) 1.34 (+0.29)
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