Central Banks: The Heat Is On




THE HEAT FIRMLY ON AT FED & BOE POLICY MEETINGS

This week saw sharp fluctuations in bond markets. Shorter-dated yields have generally risen, and some in abrupt fashion, reflecting growing concerns about the scale of monetary tightening that central banks may soon enact. Evidence of rising inflationary pressures and hawkish comments, notably from the Bank of Canada, have further fuelled those concerns. Even countries or regions where policymakers have remained dovish, such as Australia and the Eurozone, have seen financial markets price in a considerable risk of increases in policy interest rates in the relatively near future. Longer-dated bonds have been less sure about how to react. Yields in some markets at first fell sharply, possibly on concerns that aggressive policy tightening could cause a sharp slowdown in economic activity. They have subsequently rebounded, but 10-year yields in some markets, including the US and UK, remain below their levels of a week ago. US and European equity markets seem set to end the week either up or down only modestly, suggesting that for now they are less concerned about monetary policy developments. However, equity markets elsewhere have in some cases seen a bigger reaction. Against this backdrop, the focus in the coming week will be on monetary policy updates from the US Federal Reserve (Wed) and Bank of England (Thu). Next week also sees the global spotlight on Glasgow and the Cop26 conference on climate change. While it may have a less immediate impact on markets, decisions made there could have potentially significant economic effects over the medium term. Finally, the October US labour market report is published on Friday.


FED TO START TAPERING

It has for some time been expected that the Fed would announce a start to the tapering of its asset purchase programme after next week’s policy meeting. In his last comments before the Fed started its pre-meeting purdah, Fed Chair Powell said that now was the time to start tapering and so a formal announcement on Wednesday seems inevitable. Less certain is the path of tapering. Until recently it was generally assumed that the Fed would announce an initial reduction of $15bn to its $120bn monthly programme. With similar sized reductions in the subsequent months, that would end the process around mid-2022. However, more recently some Fed policymakers have said that they favour a faster rate of reduction. If the Fed does opt for a quicker pace of tapering or even indicate that the pace may pick up later this will be seen as a more hawkish signal that it is potentially readying itself for an earlier rise in interest rates. Aside from this possible signal, next week’s update is unlikely to say much new on interest rates. In his pre-blackout comments Powell also said that he was not yet ready to start discussing rate increases. That suggests that while next week’s policy statement and Powell’s press conference will stress remaining vigilant regarding the rise in inflation and the need to act, if necessary, the Fed will not go further at this point. Indeed, Powell is likely to repeat that the bulk of the current rise in inflation is “transitory” and that the ‘bar’ in terms of the evidence they want to see to justify a rate hike is much higher than it was for tapering asset purchases.


BOE LOOKS SET TO HIKE INTEREST RATES

Speculation is rampant that the BoE will hike interest rates next Thursday, with markets already discounting a 15 basis-point increase. Expectations have been fuelled in large part by hawkish comments from BoE Governor Bailey and Chief Economist Pill that some action is likely required in response to the ongoing rise in inflationary pressures. Although others on the MPC have also said that they are not ready to vote for a hike at this time, this has not been enough to cool expectations. There is arguably a good case for waiting for more data, including developments after the ending of the ‘furlough’ scheme. What might be crucial, however, is that most BoE policymakers may calculate that an early move may potentially help to stabilise inflation expectations and mean that less action will be required later. So, while the decision is finely balanced, we expect a 0.15% hike next week. However, support for this is unlikely to be unanimous and it will be interesting to see how wide the spilt is and understand the main arguments on both sides. The Bank of England will also need to signal and explain what it expects to happen next. Markets are currently discounting several more rate rises over the next 12 months, taking the base rate above 1%. While we agree that some further action may be necessary, it appears that market expectations are probably excessive at this time. Past comments from the MPC would suggest that they share this view and so may want to signal that to markets. However, they also need to consider how their comments will be read and feed into other parts of the economy. In particular, they will want to ensure a firm grip on inflation expectations and so will probably want to stress that upside inflation risks point to the need for further action. The message that rates are likely to rise further, but probably not by as much as markets expect, may not be easy to convey at a time of such heightened market expectations and so there is a risk of confusion. Certainly, the details of the BoE’s latest forecasts in its Monetary Policy Report will need to be followed closely.


US PAYROLLS LIKELY TO BE STRONGER IN OCTOBER

The data calendar will largely be overshadowed by policy developments but Friday’s US Labour Market report will still be of interest. A strong outturn for October Non-farm payrolls may further fuel expectations that the Fed will need to tighten policy more aggressively


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