Against a backdrop of a broadly unchanged economy and outlook, a hawkish tone from several central banks is pushing real rates higher, at the wrong time.
Policymakers for the Bank of Canada, the Bank of England, the European Central Bank (ECB), and the Fed have provided a variety of hints that reasoning for a more aggressive stance may be influencing central bank thinking. This is far from uniform; the Bank of Japan remains determinedly dovish, and there have been some important dovish messages from individual central bank members, including regional Federal Reserve Bank Presidents James Bullard and Neel Kashkari. Nevertheless, central banks, along with the Bank for International Settlements, have made some common points in these communications. Following the more hawkish commentary global rates have risen, led by European rates: 10-year bunds rose more than 30 basis points in about a week. Many fixed-income assets in the Risk Appetite Index were clustered near zero, and the worst performing were inflation-linked bonds, because real rates rose more than nominal rates.
Unwillingness to underestimate inflationOne point to note is that central bankers have pointedly dismissed recent weakness in inflation as temporary. The ECB has also drawn comfort from a slight upward move in a variety of measures of underlying inflation, even though headline measures remain subject to the vagaries of global energy prices. Rather than repeat our recent observations about inflation, it’s important to stress that there is no automatic link between an inflation forecast and an interest-rate decision. What matters for policy rates is what central bankers want to matter for rates. The Fed, in particular, seems wedded to the notion that the ever-tightening labor market must push up wages and inflation. With this model in mind, the Fed is bound to dismiss as irrelevant any period when inflation falls and the labor market tightens. For the Fed, then, it’s almost as if the desire to tighten is driven by the state of the labor market, rather than the outlook for inflation.
It’s important to stress that there is no automatic link between an inflation forecast and an interest-rate decision. What matters for policy rates is what central bankers want to matter for rates.
New thinking on asset price configurationsA second interesting point is the argument that, since financial conditions remain accommodative (because equity markets remain strong and credit is easily available via banks and bond markets), the interest-rate path associated with a given desired monetary policy stance needs to be higher. The Bank for International Settlements recently published a paper on this idea, and its lead author, Claudio Borio, was one of the few heavyweight central banking officials who expressed serious concern about monetary policy and financial market imbalances before the 2008 financial crisis. We can be sure that his ideas are being at least thoroughly discussed across the G10 central banks.
The chief concern is that key central banks seem to have articulated more hawkish views recently, even though they do not have an outlook that differs from ours in any important or dramatic way.