Some central banks started to move on policy

The Reserve Bank of New Zealand which has already hiked once in October by 25-bps and looks set to follow this with another 25-bps hike to 0.75% this week.

Bond yields at the front end of the curve remain volatile and this seems likely to continue as traders and investors juxtapose soaring inflation with weaker growth dynamics. This week’s PMI releases for November should show both of these trends quite clearly, particularly in the eurozone where the fourth Covid wave is hitting business and consumer sentiment. 

In the US too, consumer sentiment is flailing although this seems more due to concerns about future real income as inflation surges than the pandemic. Central banks have to balance these two risks and, right now, the Federal Reserve is unbalanced as it errs too much to the employment side of its mandate and not enough to the price stability objective. This week’s October PCE price data from the US should show annual inflation up to 5.10% from 4.40% and, while inflation should stabilize and fall in time, it won’t fall as far as the Fed anticipates. The Fed too sees the risks as lying on this side which is why its rhetoric is becoming more hawkish. For instance, there’s increasing talk that the taper, which currently stands at USD15bn per month will be increased to bring the end-point into the spring of next year rather than June as currently envisaged. 

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said: “We can see this happening although we are not sure it will come as soon as the December meeting. We have pushed our rate call for next year up to two rate hikes from one. We see the first in Q3 and the second in Q4 which is not far from market pricing but clearly ahead of the Fed’s last DOTS plot in September which saw an even split between those anticipating one rate hike next year and those that saw none. A faster pace of Fed tightening should lift yields but this looks as if it is going to be a very bumpy rise as the market weighs the inflation surge against weaker growth and, if the European Covid surge crosses to the US, the bumps in the road towards higher yields could be very big ones indeed”.

Some other central banks have left the Fed in their wake even though, on the surface at least, inflationary pressure appears more muted than that we are seeing in the US. One such bank is the Reserve Bank of New Zealand which has already hiked once in October by 25-bps and looks set to follow this with another 25-bps hike to 0.75% this week. The market anticipates that the Bank will keep these rate hikes coming thick and fast. 

“We are also seeing many emerging market central banks hiking rates, with South Africa’s Reserve Bank a notable addition last week. Again, it seems to us that many of these central banks are not experiencing the same scale of inflationary pressure as we see in the US, not least because the government in the US has eased fiscal policy much more than elsewhere during the pandemic. In our view, the dichotomy between the US and many other countries is down to two factors. The first is that the Fed has a dual mandate and now an average inflation target. With employment still more than 5m from full employment levels, the Fed will seemingly wait to hike rates, while some overshooting of inflation is desirable when it comes to hitting the 2% PCE target on an average basis. The second factor is that some countries outside the US, particularly in emerging markets probably have an eye on the possibility of financial tensions, such as exchange rate weakness, should they not be pre-emptive and start to lift rates modestly at this early stage”, Mr. Steve Barrow said. 

The Fed, for its part, does not have to concern itself with exchange rate weakness, should it start to fall behind the curve. With high levels of invoicing of exports and imports in dollars, the exchange rate pass-through from dollar weakness is much less than we see elsewhere. The US can still import inflation, of course, but it is more likely to be because inflation overseas is rising, not through dollar weakness. Looking ahead, the Fed will continue to lag behind many other countries although there will be notable exceptions to this, not least the ECB and BoJ.