The Tightening Part 3 - Open Mouth Operations eat Open Market Operations for breakfast

England and Europe are also flying with the Hawks

Breaking new ground, last week the Bank of England lifted official interest rates by o.15% to 0.25%. The first Central Bank to do it.

Roughly around the same time the European Central Bank said that while it would leave official rates on hold for the minute, it was working on guidance to reverse QE (quantitative easing) and taper bond buying to zero much faster than the market expects.

This hawkish tone rings the same bells as the U.S. Federal Reserve, which hit the market hard with its guidance for an accelerated taper, interest rate and QT (quantitative tightening).

But so far there’s only been one actual increase in interest rates (up 0.15%) and two decreases (down by 0.10% and 0.05%).

Net net, that makes zero - but it’s never that simple as the increase occured in the UK and the decreases occured in the world’s second largest economy, China. Uh oh.

Despite this, there is a distinctly hawkish tone everywhere, other than for in China where the recovery seems to be slowing possibly due to the effects of the middle kingdom’s zero-COVID policy.

Also, key bond markets are experiencing rising yields as the tightening starts to get priced in.

Doves are now Hawks due to COVID-supply disruption trickle down

Pretty much since the GFC, most central banks have been accommodative and dovish. That appears to have changed for the moment, but could change back again.

The reason for all the hullaballoo over official and prime interest rates now, is that all governments want to be re-elected in due course and to do that they want consumer price inflation under control. In support of that, many feel that raising interest rates, stopping bond purchases and shrinking balance sheets is the answer to high consumer prices.

If it was demand-only inflation, then yes that should work.

But as always with the virus it’s not that simple. Inflation appears to be transitory, particularly in relation to energy and food (i.e., non-core inflation) and caused by a post-COVID inability to supply demand, and some bring-forward demand (stockpiling).

If the world and supply chain hubs can get on top of the virus, this should dissipate. Plus, the year on year calculation of 7% in the U.S., for example, is being compared to a very low base which many people seem to forget.

But saying that inflation is transitory (even if it is) is not something central bankers can continue to say when governments are trying to appease voters for the reasons stated above. Also, there is a risk that inflation may become entrenched in wages, which could have lasting effects.

There are some fiscal (welfare) tools that can be used for non-core items, like energy price regulation, caps and compensation which have been instituted in Belgium, Bulgaria, France, Spain and Sweden.

That said, bad weather and increasing fertiliser prices (also a trickle down effect from lockdowns) and transportation blockages which are compounding food shortages (even here in WA) is a tough one for food and other products. And there’s still not much let up in the motor vehicle and truck supply chain.

So, like it or not, rightly or wrongly, the world’s central bankers are saying inflation is not transitory and that they will increase rates, wind in bond buying and potentially shrink balance sheets, this year.

That’s the guidance that’s been factoring into markets.

So far all financial market moves have been from guidance

The simple point I want to make is that the most powerful tool held by a central bank is guidance - not necessarily the eventual action.

It’s like open mouth operations eat open market operations for breakfast.

Put another way, guidance about what will come is what moves financial markets and once the actual event arrives the guidance should already be baked into a rate, index, currency, commodity price, piece of real estate. That also assumes that the guidance is credible.

And the current guidance points to increasing opportunities in bonds, and a rotation out of low/future earnings equities.

What we’ve actually been seeing over the last three weeks is bond yields up plus rotations out of high beta/bring forward earnings equities, i.e., growthy growth stocks, and into value and tactical assets, i.e., low PE/high dividend stocks across industrials, energy and oil, etc.

This does not mean that there won’t be a relief rally in bring forward earnings assets (I mean, just look at crypto) but there is definitely a sense of a changing narrative, as I wrote about in Part 1.

What’s actually going on at the policy level, is set out below.

One interest rate move, the rest is guidance

Rate increases

Bank of England - 0.15% increase to 0.25% but Omicron, potential new lockdowns and cratering business confidence saved it from a larger hike favoured by some of the governors.

Rates, steady with future guidance only

Federal Reserve - No change yet - heavy handed hawkish guidance that taper will end in March, rates will lift off, balance sheet will be run-off and shrunk at later date in orderly and predictable manner; with overall intent to move from accommodative policy to substantially less accommodative policy to one that’s not accommodative at all.
European Central Bank - No change yet - working on forward guidance over the March and June meetings and will remove QE and taper bond buying faster than what markets are expecting. For the first time since mid 2019, the German Bund (bond) yield went positive printing 0.06%.
Bank of Canada - No change yet - decided to keep policy rate unchanged, remove commitment to hold it at 0.25% floor, signalled rates can be expected to increase going forward with timing and pace of increases guided by Bank’s commitment to achieving 2% inflation target.
Reserve Bank of Australia - No change - RBA will not be increasing interest rates until actual inflation is sustainably within the 2% to 3% range, but bond purchases will cease on February 10, as I wrote about in Part 2.
Bank of Japan - No change - far too early in Japanese recovery to call it.

Official interest rate cuts

People’s Bank of China - First cuts since April 2020 with a cut of 0.10% (one year down to 3.7%) and 0.05% (5 year mortgage rate down to 4.6%).

President Xi of China would prefer that the Fed keeps interest rates low. Uh oh.

The others will follow the Fed, sooner or later, and the jury is out as to how high the Fed can raise interest rates.

Now we wait for inflation numbers, and then the next Fed meeting in March for further guidance.

In the meantime, and based on some of the price action we’ve been seeing across risk assets, open mouth operations are eating open market operations for breakfast.

Mike

Michael GanonFebruary 7, 2022#economy, #finance, #interestrates, #business, #trade, #transformation, #strategy, #ceos, #cfos, #c-suite, #currency, #construction, #mining, #renewables, #technology, #leadership, #india, #china, #australia, #perth, #education, #research, #uk, #growth, #retail, #businessowners, #future, #brexit, #nextlevelcorporate, #mikeganon, # community, #tradewar, #America