One of the most frustrating aspects of the last few months has been the fact that some central banks have done things which I applaud , while others have done things which I find both incomprehensible and incompetent. In the current climate, it’s easy to misread the markets.
Take the Bank of Canada (BoC). It had already hiked interest rates once back in July to take its cash rate from 0.5% to 0.75%. This was in spite of inflation being only 1% versus its soft target of 2%. However, in a move only partially priced by the market (and forecast by only six of 33 economists surveyed by Bloomberg) this was followed up with another hike at its September meeting. Most market observers had assumed (naively as it turns out) that with inflation languishing around one percentage point below its target, the BoC would be in no rush to embark on a hiking cycle.
Nothing wrong with the BoC’s actions. I don’t think it will be damaging, and I see the virtue in getting a few hikes in when the data allows.
But the market misread its actions because most participants have been conditioned to do so by other central banks such as the US Federal Reserve. The Fed has never hiked in consecutive meetings during this cycle. That’s in spite of consumer price inflation reaching 2.7% earlier this year and in spite of unemployment in the US being a full two percentage points lower in the US compared to Canada. So the US has higher inflation, lower unemployment (also lower consumer debt and lower interest rate sensitivity across the economy. It is more closed and thus less currency sensitive, and less energy reliant.) Yet the BoC is now out-hawking the Fed.
The Fed made this even worse over the summer. First Lael Brainard, then Janet Yellen, voiced anxieties about the near-term decline in spot inflation. (One minute this decline was transitory. The next, it was reason for panic.) We even had widely-recognised uber-dove and Goldman Sachs alumnus Neel Kashkari stating that the hikes instigated so far by the Fed had already done obvious economic damage. He didn’t give details as to the location of this “obvious damage”, and even seemed to intimate that he was using the 2s10s curve as a measure of economic activity. I don’t even know where to start with that one. Maybe I should explain that the $4.5 trillion of mortgage-backed securities and Treasuries purchased by his employer may have had just a tiny impact on those price signals. But why let reality get in the way of what some might describe as deluded pseudo-scientific dogma?
Elsewhere, the central bank confusion continues. The Bank of England has low unemployment and high inflation. Yet it remains on hold, because the bogey man may - or may not - be coming. In Sweden, the Riksbank has an economy on fire and above-target inflation. Yet here, too, policy is on hold because in essence it has outsourced its policy to the European Central Bank (ECB). Meanwhile, the ECB either is worried, might be worried or is completely not worried about the rally in the euro. But in spite of producing research suggesting that the recent rally would lower its inflation forecast by around 0.9 percentage points the ECB staff lowered its forecasts by only 0.1 pp.
Sometimes it seems like the ECB might just be making this up as it goes along. It is likely to taper its asset purchases before the end of the year, as long as the euro isn’t too strong, which it won’t be if it doesn’t taper.
Meanwhile, President Trump and Kim Jong-Un are at loggerheads. Threats, counter threats, missile and nuke tests and a lack of obvious diplomacy have resulted in a further deterioration in relations between the US and North Korea. That, coupled with the tragic devastation emanating from Hurricanes Harvey and Irma, resulted in further flight to quality bids which pushed sovereign bond yields lower.
Interestingly, risk markets didn’t really suffer, suggesting that this may be less of a flight to quality and more of a function of abundant liquidity and positioning. But that is scant comfort to those investors who had been positioned for higher yields.
And then we have US politics. Trump sided with the Democrats to agree to kick the can a short way down the road with respect to the continuing resolution and the debt ceiling. That means we now have a critical financial and political deadline right after an important Fed meeting, and right before Christmas. What could possibly go wrong?