SACK POWELL YESTERDAY!!!

"With fin­an­cial mar­kets already on a fest­ive high, after deliv­er­ing dovish dot plots Pow­ell should have dialled up the cau­tion. Stock mar­kets pre­dict­ably ral­lied, with the S&P 500 near­ing a twoyear high. Bond yields also dropped. These moves amount to a not­able loosen­ing of fin­an­cial con­di­tions — which could be a prob­lem for the Fed if infla­tion does indeed prove resi­li­ent."

Financial Times

Financial Times Asia16 Dec 2023

Finance

Cent­ral bankers are singing from dif­fer­ent hymn sheets

The tim­ing and extent of interest rate cuts are now in the spot­light

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As far as interest rate decisions are con­cerned, cent­ral banks ended 2022 and 2023 on the same page. Last year, in their pre-Christ­mas meet­ings the US Fed­eral Reserve, European Cent­ral Bank and Bank of Eng­land all raised rates by 50 basis points as they fought soar­ing infla­tion. This year, with price growth fall­ing rap­idly, they all kept their — now much higher — rates unchanged. But their accom­pa­ny­ing fest­ive mes­sages this week hit very dif­fer­ent notes. To mis­quote Leo Tol­stoy: all cent­ral banks are happy that infla­tion is fall­ing, but each is unhappy in its own way that it is not fall­ing fast enough.

After wait­ing too long to tighten policy ini­tially, cent­ral banks rightly want to ensure high infla­tion is com­pre­hens­ively beaten. The case to keep high rates on hold was indeed strong. In Amer­ica, although infla­tion has fallen sharply to 3.1 per cent, its jobs mar­ket is still hot and con­sumer spend­ing is resi­li­ent. In Bri­tain, core infla­tion — which excludes energy and food — is still well above its long-term aver­age at 5.7 per cent. As for the euro­zone, while infla­tion is within half a per­cent­age point of its tar­get, wage growth looks sturdy and fur­ther salary set­tle­ments next year war­rant vigil­ance.

But with the impact of higher rates still feed­ing through to house­holds and busi­nesses, the prob­ab­il­ity of under­shoot­ing the 2 per cent tar­get has risen every­where. The risk, though, is not the same on both sides of the Atlantic. It is per­haps higher in the euro­zone, where time­lier meas­ures sug­gest pay growth is already on its way down. Yes­ter­day, for­ward indic­at­ors of ser­vices and man­u­fac­tur­ing activ­ity also poin­ted to a deeper slow­down ahead. Eco­nomic resi­li­ence in Amer­ica and elev­ated wage growth in Bri­tain sug­gest core infla­tion is, however, likely to be stick­ier in those coun­tries. With that in mind, the sig­nalling from the Fed and the ECB, in par­tic­u­lar, seemed off the mark.

The Fed came across as dovish. Its new dot plot of interest-rate pro­jec­tions sur­prised by imply­ing three 25bp rate cuts in 2024, up from just two. Its for­ward guid­ance also watered down the pos­sib­il­ity of fur­ther increases. But chair Jay Pow­ell also did little to push back on the notion that the Fed is now pivot­ing to cuts.

With fin­an­cial mar­kets already on a fest­ive high, after deliv­er­ing dovish dot plots Pow­ell should have dialled up the cau­tion. Stock mar­kets pre­dict­ably ral­lied, with the S&P 500 near­ing a twoyear high. Bond yields also dropped. These moves amount to a not­able loosen­ing of fin­an­cial con­di­tions — which could be a prob­lem for the Fed if infla­tion does indeed prove resi­li­ent.

By con­trast, the ECB pres­id­ent, Christine Lagarde, was hawk­ish, reit­er­at­ing that offi­cials “did not dis­cuss rate cuts at all”. But lower infla­tion fore­casts opened the door to a pivot, and reit­er­ated the greater risks of under­shoot­ing in the euro­zone. The Frank­furt-based bank seems too stead­fast, and could now make the mis­take of loosen­ing rates too slowly.

The BoE was per­haps most on point with its mes­saging. It came across as defi­antly hawk­ish, with three out of nine com­mit­tee mem­bers also vot­ing for a 25bp rate rise. Higher UK con­sumer con­fid­ence and eco­nomic activ­ity data yes­ter­day backed up its tone.

With mar­ket reac­tions and policy lags to factor in, pulling off a suc­cess­ful pivot in interest rates is not going to be easy any­where. Dif­fer­ing eco­nomic cir­cum­stances, moreover, mean the US, EU and UK cent­ral banks will not always be on the same page. But, judging by their end-of-year show­ing, it is clear that none is totally sure how far or when they will need to make cuts. Here’s hop­ing they can start 2024 with a bit more clar­ity.