It was the week of the central banks. The Bank of England raised interest rates by 15 basis points, the US Fed hinted at three rate hikes and a reduction in the buy-back programme. What exactly the ECB is aiming for is not entirely clear to market analysts. One thing is clear: a rate hike is the ultimum remedium for the central bank of President Christine Lagarde.
Columbia Threadneedle
According to Adrian Hilton, head of global currency markets at US-based Columbia Threadneedle Investments, the major western central banks no longer see downside economic risks as a licence to let inflationary pressures run wild.
Until recently, the Fed, the Bank of England (BoE) and the European Central Bank (ECB) stressed the transitory nature of inflation, which they said was rooted in supply-side distortions and increased energy prices.
“Now, to varying degrees, monetary authorities are choosing to look past the risks of the Omicron variant (or even seeing it as a further inflationary risk) and are instead focusing on strengthening their credibility in the fight against inflation,” Hilton said.
Asset purchases are now being accelerated for this reason. The Bank of England was the first central bank to raise the policy rate by 15 basis points to 0.25 per cent. According to Hilton, the persistently low level of long-term bond yields is a sign that the market has so far not been inclined to accept sustainably higher interest rates.
Hilton continues: “Our core view is that the long-term structural factors of low inflation and low bond yields are still in place and that neutral interest rates will not turn out higher in this cycle than in previous cycles. Therefore, we think it is reasonable for the market not to steepen yield curves even when inflation is rising. Moreover, we have an increasing preference for the segment of yield curves with a 3-5 year maturity, where interest rates appear full and the carry attractive.”
“The ECB does remain sensitive to government bond segmentation risk, according to Columbia Threadneedle’s view. Although the ECB will be tapering its buying programmes, it will want to guard against too much widening of peripheral country spreads.” For this reason, the US fund house is quietly sitting in Italian and Spanish government bonds.
Swissquote
According to Ipek Ozkardeskaya, senior analyst at banking group Swissquote, the rally in US equities is likely to continue in the medium term. “Firstly, the Fed will expand its balance sheet in the coming months, even at twice the pace of tapering the purchase programme. Secondly, corporate profits have been strong enough this year, which is reassuring because things will not collapse overnight.”
Ozkardeskaya believed that despite the expectation that higher interest rates will be beneficial to value stocks, major US tech companies should continue to do well. “However, volatility may increase and downward corrections may occur more frequently at the index level, but I’m not sure the bumps in the road can keep the S&P500 and Nasdaq from gaining another 5 to 7 per cent. A new record before the end of this year is not inconceivable.”
Ozkardeskaya is not impressed by the hawkish adjustment and ECB policy. The ECB announced it would end the PEPP programme by next March, but added that the bank would double APP purchases to ease the transition. “By doing so, the ECB wants to fool Mr. inflation in the hope of convincing him to pack his bags.”
“But that is not all. The ECB will continue to invest cash from maturing bonds for longer, and will keep the PEPP contingency in abeyance, ready to be deployed at short notice in the event of turbulence. The latest changes are better than nothing and should give the euro a boost, but they will not be enough to keep the ECB pigeons safe for the next meetings,” Ozkardeskaya concluded.
OHV Asset Management
“Until recently, central banks could afford not to change the very generous policy with the argument that inflation was mainly caused by temporary factors. But the fact that confidence allows these central banks to use only words for a while without adding deeds does not mean that they can continue to do so forever”, was what Edin Mujagic, chief economist at OHV Asset Management had to say.
At the Fed, headed by Jerome Powell, they understand very well that words must be followed by deeds, witness the press conference on 15 December, Mujagic said. “The temporary factors driving inflation are stronger and more persistent,” said the Fed chief, immediately adding that the likelihood of high inflation taking deep root in the economy has increased. It was a relief to hear Powell say that high inflation is a threat to full employment and economic development,” Mujagic said.
The Fed expects to raise official interest rates three times in 2022, followed by as many increases in 2023. Assuming the usual 25-basis-point increments, the Fed’s official rate could be between 0.75 and 1 per cent by the end of 2022 and between 1.50 and 1.75 per cent by Christmas 2023. The Fed has faced up to reality and is acting accordingly.
“Despite Powell’s hawkish statements, stock prices rose,” Mujagic continued. “This not only says that the market believes monetary tightening will be calibrated to prevent unwanted high inflation without harming the economy, it also means that the Fed has prepared the market very well for the 15 December message. The announcement of the end of the purchase programme and as many as six rate hikes in two years therefore came as no surprise to investors, resulting in calm and further rising prices.”
Mujagic is less satisfied with the approach. “Despite the promise to end the emergency buying programme in March and double the regular buying programme, interest rates are still going nowhere. That is confusing. Economic growth is high, there is no risk of recession, inflation is at 5 per cent; in short, both the economic and the inflation picture have changed significantly for the better.”
“Where the US is planning to make significant policy changes as well, the ECB is making only some cosmetic, marginal changes. That actually says everything about what we can expect in the coming years: relatively responsible policies from the Fed and persistently irresponsible policies from the ECB.”