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November 28, 2022
SGH Insight
European Central Bank Executive Board member Isabel Schnabel, who we have long considered to be the most important and influential thought leader on the Board in support of President Christine Lagarde, delivered a speech over the US Thanksgiving holiday in which she laid out the case for another aggressive rate hike when the ECB Governing Council next meets on December 15.
Some of the financial press summarized her speech as simply stating that “incoming data so far suggest the room for slowing down the pace of interest rates remains limited,” but in our view Schnabel went significantly farther than that, and the real message of this important speech may have been lost in the holiday markets.
In her keynote speech on Thursday at the Bank of England Watchers conference, focused on the interplay between monetary and fiscal policy, we believe Schnabel intended to make a full-throated case to the public, markets, and to her fellow policymakers for more frontloading of rate hikes, meaning another 75 bp hike in December.
Market Validation
Some of the financial press summarized her speech as simply stating that “incoming data so far suggest the room for slowing down the pace of interest rates remains limited,” but in our view Schnabel went significantly farther than that, and the real message of this important speech may have been lost in the holiday markets.
In her keynote speech on Thursday at the Bank of England Watchers conference, focused on the interplay between monetary and fiscal policy, we believe Schnabel intended to make a full-throated case to the public, markets, and to her fellow policymakers for more frontloading of rate hikes, meaning another 75 bp hike in December.
1/19/23 Market Watch
Lagarde tells traders they are wrong to bet on slower pace of ECB interest rate rises
Benchmark European bond yields rose and the euro was firm after Christine Lagarde told traders they were wrong to bet the European Central Bank is about to slow the pace of interest rate rises.
The ECB president pushed back against reports earlier this week that suggested the central bank might trim its interest rate hikes from 50 basis points to 25 basis points at its next meeting on February 2nd in response to signs inflationary pressures were easing.
"I would invite [financial markets] to revise their position; they would be well advised to do so," Lagarde told a panel at Davos.
ECB Account of December monetary policy meeting
A large number of members initially expressed a preference for increasing the key ECB interest rates by 75 basis points, as inflation was clearly expected to be too high for too long and prevailing market expectations and financial conditions were plainly inconsistent with a timely return to the ECB’s 2% inflation target. Hence, the worsened inflation outlook required an interest rate hike larger than that priced in by markets. Failing to exceed market expectations could be regarded as confirming market views on the future policy path, which could result in the yield curve not shifting upwards to the extent required to bring inflation back to target. It was argued that, given the unfavourable data and inflation outlook that had become available with the December projections, the Governing Council’s data-dependent, meeting-by-meeting approach required an interest rate increase of the same size as in October to counter an unwarranted loosening of financial conditions and the monetary policy stance. It was maintained that a 75 basis point increase would speak for itself and was preferable to relying on the alternative approach of a 50 basis point move accompanied by strengthened communication on the way forward. A risk management approach to addressing persistent inflation pressures was also seen as calling for decisions that erred on the side of determined action to prevent an unanchoring of inflation expectations. Raising interest rates by less than 75 basis points would send the wrong message and risked being perceived as inconsistent with the 2% inflation target in the medium term, thereby reinforcing the perception of an asymmetry in the Governing Council’s reaction function.
Some of these members, nonetheless, expressed their willingness to agree on a 50 basis point rate rise if a majority were to support the proposal put forward by Mr Lane, taking into account the strengthened communication on the Governing Council’s policy intentions and the enhanced message that the Governing Council would continue raising rates significantly at a sustained pace, which were also part of the proposal. This was in some ways seen as broadly equivalent to raising rates by 75 basis points at the present meeting, because a less frontloaded but steadier approach to bringing interest rates to restrictive levels could be seen as consistent with the more persistent nature of the inflation process and continued elevated uncertainty.
Taking all into account, a broad majority of members supported Mr Lane’s proposal to raise the key ECB interest rates by 50 basis points and to communicate that interest rates would still have to rise significantly at a steady pace to reach levels that were sufficiently restrictive to ensure a timely return of inflation to the ECB’s 2% medium-term target.
Lagarde tells traders they are wrong to bet on slower pace of ECB interest rate rises
Benchmark European bond yields rose and the euro was firm after Christine Lagarde told traders they were wrong to bet the European Central Bank is about to slow the pace of interest rate rises.
The ECB president pushed back against reports earlier this week that suggested the central bank might trim its interest rate hikes from 50 basis points to 25 basis points at its next meeting on February 2nd in response to signs inflationary pressures were easing.
"I would invite [financial markets] to revise their position; they would be well advised to do so," Lagarde told a panel at Davos.
ECB Account of December monetary policy meeting
A large number of members initially expressed a preference for increasing the key ECB interest rates by 75 basis points, as inflation was clearly expected to be too high for too long and prevailing market expectations and financial conditions were plainly inconsistent with a timely return to the ECB’s 2% inflation target. Hence, the worsened inflation outlook required an interest rate hike larger than that priced in by markets. Failing to exceed market expectations could be regarded as confirming market views on the future policy path, which could result in the yield curve not shifting upwards to the extent required to bring inflation back to target. It was argued that, given the unfavourable data and inflation outlook that had become available with the December projections, the Governing Council’s data-dependent, meeting-by-meeting approach required an interest rate increase of the same size as in October to counter an unwarranted loosening of financial conditions and the monetary policy stance. It was maintained that a 75 basis point increase would speak for itself and was preferable to relying on the alternative approach of a 50 basis point move accompanied by strengthened communication on the way forward. A risk management approach to addressing persistent inflation pressures was also seen as calling for decisions that erred on the side of determined action to prevent an unanchoring of inflation expectations. Raising interest rates by less than 75 basis points would send the wrong message and risked being perceived as inconsistent with the 2% inflation target in the medium term, thereby reinforcing the perception of an asymmetry in the Governing Council’s reaction function.
Some of these members, nonetheless, expressed their willingness to agree on a 50 basis point rate rise if a majority were to support the proposal put forward by Mr Lane, taking into account the strengthened communication on the Governing Council’s policy intentions and the enhanced message that the Governing Council would continue raising rates significantly at a sustained pace, which were also part of the proposal. This was in some ways seen as broadly equivalent to raising rates by 75 basis points at the present meeting, because a less frontloaded but steadier approach to bringing interest rates to restrictive levels could be seen as consistent with the more persistent nature of the inflation process and continued elevated uncertainty.
Taking all into account, a broad majority of members supported Mr Lane’s proposal to raise the key ECB interest rates by 50 basis points and to communicate that interest rates would still have to rise significantly at a steady pace to reach levels that were sufficiently restrictive to ensure a timely return of inflation to the ECB’s 2% medium-term target.
January 13, 2023
SGH Insight
The Bank of Japan (BOJ) will tilt guidance toward an April exit of ultra easy policy at next week’s meeting as Prime Minister Fumio Kishida prepares to hand over the reins to a new Governor ahead of Haruhiko Kuroda’s departure before April 8.
A breach of the BOJ’s upper limit on 10-year government bond yields (JGB) Friday, forced a round of central bank bond buying and has increased pressure on the nine-member board to move again after it raised the upper limit on the 10-year yield to 0.5% from 0.25% in December.
Whether the BOJ opts to tweak the limit again at this or at the March 9-10 meeting, we expect the BOJ to eliminate yield curve control (YCC) during April, once Kuroda’s successor takes office.
At his December post meeting press conference, Kuroda stridently characterized the move as a technical tweak to improve market functioning. Since 2016 the BOJ has operated the YCC limits to achieve its 2% inflation target. The policy is a band set around the 0% target to allow long-term rates to move up or down by 0.50bp.
The January 17-18 meeting has been billed as a “technical” discussion to prepare the market for the BOJ to end its curve control policy (YCC) before April, once Kuroda’s successor takes office.
In particular the BOJ is uncomfortable with the kink in the curve, an inversion that shows a gap between seven- to nine-year yields and 10-year yields. In addition to how to correct ongoing market distortions from YCC, the meeting agenda will include an upward revision to the outlook for consumer prices and support further bond purchases.
Market Validation
A breach of the BOJ’s upper limit on 10-year government bond yields (JGB) Friday, forced a round of central bank bond buying and has increased pressure on the nine-member board to move again after it raised the upper limit on the 10-year yield to 0.5% from 0.25% in December.
Whether the BOJ opts to tweak the limit again at this or at the March 9-10 meeting, we expect the BOJ to eliminate yield curve control (YCC) during April, once Kuroda’s successor takes office.
At his December post meeting press conference, Kuroda stridently characterized the move as a technical tweak to improve market functioning. Since 2016 the BOJ has operated the YCC limits to achieve its 2% inflation target. The policy is a band set around the 0% target to allow long-term rates to move up or down by 0.50bp.
The January 17-18 meeting has been billed as a “technical” discussion to prepare the market for the BOJ to end its curve control policy (YCC) before April, once Kuroda’s successor takes office.
In particular the BOJ is uncomfortable with the kink in the curve, an inversion that shows a gap between seven- to nine-year yields and 10-year yields. In addition to how to correct ongoing market distortions from YCC, the meeting agenda will include an upward revision to the outlook for consumer prices and support further bond purchases.
MT Newswire 1/18/23
Bank of Japan Defies Market Speculators, But Pressure to End YCC
(MT Newswires)
The Bank of Japan defied market pressure and kept its ultra-low interest rate policy firmly in place after a two-day monetary policy meeting that ended today.
The yen fell and yields on Japan's government bonds plunged on the news, while stocks surged on the prospect of continued low rates.
But with current BoJ Governor Haruhiko Kuroda only in office until April, speculation of imminent change to the bank’s policy regime is unlikely to go away.
Bank of Japan Defies Market Speculators, But Pressure to End YCC
(MT Newswires)
The Bank of Japan defied market pressure and kept its ultra-low interest rate policy firmly in place after a two-day monetary policy meeting that ended today.
The yen fell and yields on Japan's government bonds plunged on the news, while stocks surged on the prospect of continued low rates.
But with current BoJ Governor Haruhiko Kuroda only in office until April, speculation of imminent change to the bank’s policy regime is unlikely to go away.
January 17, 2023
SGH Insight
Late last week an article came out flagging the possibility that after a 50 bp hike at the next ECB meeting on February 2, and another 50 bps on March 16, lifting the benchmark deposit rate from 2.0% to 3.0%, the “doves” within the ECB’s Governing Council might push to slow the pace of rate hikes to 25 bp increments at the following meeting on May 4.
Whether there is a stepdown or not in May, when policy rates are at 3%, is an entirely reasonable question to ask, and it may not even have to result from a Manichean struggle between doves and hawks as analysts like to frame such stories. The more debatable question to us is where the landing zone will be once the ECB crosses the 3% threshold, a zone which we continue to expect will end up in the 3.5% to 4% region.
Today, markets were jolted by a Bloomberg news article saying the ECB may consider a 25 bp hike -- not in May -- but as early as at the March meeting, when rates will be at 2.5%.
Filled with caveats (“the prospect for 50 remains likely”), that article does not capture the dynamics that matter at the ECB, and only serves to needlessly shake some positions out on the back of what has been a powerful, and very cyclically different, downdraft in US rates.
A 25 bp hike in March flies entirely in the face of the eurozone’s inflation dynamics, rate position, and explicit guidance from ECB President Christine Lagarde and a host of her colleagues after what was in fact a seminal, hawkish meeting on December 15. Unless there is a truly dramatic and completely unforeseen change in the world, it is simply not going to happen.
Market Validation
Whether there is a stepdown or not in May, when policy rates are at 3%, is an entirely reasonable question to ask, and it may not even have to result from a Manichean struggle between doves and hawks as analysts like to frame such stories. The more debatable question to us is where the landing zone will be once the ECB crosses the 3% threshold, a zone which we continue to expect will end up in the 3.5% to 4% region.
Today, markets were jolted by a Bloomberg news article saying the ECB may consider a 25 bp hike -- not in May -- but as early as at the March meeting, when rates will be at 2.5%.
Filled with caveats (“the prospect for 50 remains likely”), that article does not capture the dynamics that matter at the ECB, and only serves to needlessly shake some positions out on the back of what has been a powerful, and very cyclically different, downdraft in US rates.
A 25 bp hike in March flies entirely in the face of the eurozone’s inflation dynamics, rate position, and explicit guidance from ECB President Christine Lagarde and a host of her colleagues after what was in fact a seminal, hawkish meeting on December 15. Unless there is a truly dramatic and completely unforeseen change in the world, it is simply not going to happen.
Bloomberg 1/18/23
Villeroy Says Lagarde’s Half-Point ECB Guidance Still Valid
French official won’t speculate on size of March rate increase
Moderating inflation has prompted talk of smaller hikes
Guidance from European Central Bank President Christine Lagarde that borrowing costs will continue to be lifted in half-point steps for some time still holds, according to Governing Council member Francois Villeroy de Galhau.
Speaking to Bloomberg TV at the World Economic Forum in Davos, the Bank of France chief said it’s too soon to talk about the size of the likely interest-rate increase in March, after people familiar with officials’ thinking told Bloomberg that moderating inflation and declining energy prices may warrant a smaller hike.
“We said very clearly we still decide meeting by meeting, we are data driven, so it’s much too early to speculate about what we will do in March,” Villeroy said. “Let me remind you of the words of President Lagarde at her last press conference in December: We should expect to raise rates at a pace of 50 basis points for a period of time. Well, these words are still valid today.”
Lagarde on Dec. 15:
“So we will continue that at a steady pace. Based on the information that we have available today, that predicates another 50-basis-point rate hike at our next meeting, and possibly at the one after that, and possibly thereafter, but everything will also be determined by the review of data. So don’t assume that it’s a one-shot 50; it’s more than that.”
Villeroy Says Lagarde’s Half-Point ECB Guidance Still Valid
French official won’t speculate on size of March rate increase
Moderating inflation has prompted talk of smaller hikes
Guidance from European Central Bank President Christine Lagarde that borrowing costs will continue to be lifted in half-point steps for some time still holds, according to Governing Council member Francois Villeroy de Galhau.
Speaking to Bloomberg TV at the World Economic Forum in Davos, the Bank of France chief said it’s too soon to talk about the size of the likely interest-rate increase in March, after people familiar with officials’ thinking told Bloomberg that moderating inflation and declining energy prices may warrant a smaller hike.
“We said very clearly we still decide meeting by meeting, we are data driven, so it’s much too early to speculate about what we will do in March,” Villeroy said. “Let me remind you of the words of President Lagarde at her last press conference in December: We should expect to raise rates at a pace of 50 basis points for a period of time. Well, these words are still valid today.”
Lagarde on Dec. 15:
“So we will continue that at a steady pace. Based on the information that we have available today, that predicates another 50-basis-point rate hike at our next meeting, and possibly at the one after that, and possibly thereafter, but everything will also be determined by the review of data. So don’t assume that it’s a one-shot 50; it’s more than that.”
January 9, 2023
SGH Insight
The employment report sent mixed messages between solid job growth, a low unemployment rate, and weaker wage growth. While this may appear to be a “Goldilocks” outcome, that’s only the case if it encourages the Fed to back down from its current policy direction. That’s not going to happen just yet. The Fed can’t really back down without revising downward the 2023 dots, which is not crazy if the then high but now lower wage growth drove December’s 50bp increase in the SEP policy rate forecast, but that is not something Powell wants to do anytime soon. That would be as good as a rate cut from the market’s perspective.
Fedspeak will not yet retreat from the December SEP. Once the Fed digs itself in on a position, it takes a great deal of time and evidence to dig it out. One report isn’t going to do it. More likely it would take the totality of the data between now and the March meeting to convince the Fed it went too far with the December SEP, but even then, that view creates a potentially disastrous communications challenge for the Fed as I will explain below.
Market Validation
Fedspeak will not yet retreat from the December SEP. Once the Fed digs itself in on a position, it takes a great deal of time and evidence to dig it out. One report isn’t going to do it. More likely it would take the totality of the data between now and the March meeting to convince the Fed it went too far with the December SEP, but even then, that view creates a potentially disastrous communications challenge for the Fed as I will explain below.
Bloomberg 1/9/23
Daly Sees Fed Raising Rates Above 5% But How Far Is Unclear
Federal Reserve Bank of San Francisco President Mary Daly said she expects the central bank to raise interest rates to somewhere above 5% before pausing, though the ultimate level is unclear and will depend on incoming data on inflation.
As for the Fed’s next meeting at the end of the month, the central bank could either raise rates by 50 basis points for a second straight time or slow down to a quarter-point hike, Daly said Monday in a live-streamed interview with the Wall Street Journal.
Mary Daly
“Doing it in more gradual steps does give you the ability to respond to incoming information,” said Daly, who doesn’t vote on rates this year. She stressed that it’s too early to “declare victory” over persistent inflation.
*BOSTIC: VERY HESITANT TO DECLARE VICTORY IN BID TO COOL PRICES
*BOSTIC:SERVICES INFLATION HAS PASSED GOODS INFLATION AS PROBLEM
*BOSTIC SEES LIKELIHOOD SERVICES INFLATION WILL PROVE PERSISTENT
Daly Sees Fed Raising Rates Above 5% But How Far Is Unclear
Federal Reserve Bank of San Francisco President Mary Daly said she expects the central bank to raise interest rates to somewhere above 5% before pausing, though the ultimate level is unclear and will depend on incoming data on inflation.
As for the Fed’s next meeting at the end of the month, the central bank could either raise rates by 50 basis points for a second straight time or slow down to a quarter-point hike, Daly said Monday in a live-streamed interview with the Wall Street Journal.
Mary Daly
“Doing it in more gradual steps does give you the ability to respond to incoming information,” said Daly, who doesn’t vote on rates this year. She stressed that it’s too early to “declare victory” over persistent inflation.
*BOSTIC: VERY HESITANT TO DECLARE VICTORY IN BID TO COOL PRICES
*BOSTIC:SERVICES INFLATION HAS PASSED GOODS INFLATION AS PROBLEM
*BOSTIC SEES LIKELIHOOD SERVICES INFLATION WILL PROVE PERSISTENT
January 6, 2023
SGH Insight
Where the ECB will need to firm up its communications is in why the ratcheting up of rate hike expectations, as this stepped-up hawkishness is coming at a time when they are finally seeing some glimmers of hope in the ever elusive “peak inflation” narrative. Otherwise, we suspect, markets, and indeed many governors, will continue to misread data, inflation risks, and even mislead on the ECB reaction function.
That headline inflation relief is from nose-bleed levels and driven largely by energy prices finally coming off, but it is some relief, nevertheless. ECB officials have indeed been looking for inflation to come down around the first quarter of this year, and markets will understandably be cheered to see any confirmation of continued signs that it is, indeed, finally coming down.
But markets would be well advised against leaning too much on that narrative, as they tried to do after last November’s CPI reports. This “Phase Two” of the ECB tightening cycle, a markedly more hawkish reaction function than many in the markets or even across the Council itself were hoping for, is, as we have been writing repeatedly, entirely about shaking out the dreaded and far more problematic, underlying, core inflationary pressures that have been creeping up.
This bears repeating: “Phase Two,” if we want to call it that, is all about hitting underlying inflationary pressures.
The hawks at the ECB, including notably Isabel Schnabel at the Executive Board, have been warning about these pressures now for months, and their materialization is now coming through in spades — even in the Chief Economist’s staff economic forecast.
Market Validation
That headline inflation relief is from nose-bleed levels and driven largely by energy prices finally coming off, but it is some relief, nevertheless. ECB officials have indeed been looking for inflation to come down around the first quarter of this year, and markets will understandably be cheered to see any confirmation of continued signs that it is, indeed, finally coming down.
But markets would be well advised against leaning too much on that narrative, as they tried to do after last November’s CPI reports. This “Phase Two” of the ECB tightening cycle, a markedly more hawkish reaction function than many in the markets or even across the Council itself were hoping for, is, as we have been writing repeatedly, entirely about shaking out the dreaded and far more problematic, underlying, core inflationary pressures that have been creeping up.
This bears repeating: “Phase Two,” if we want to call it that, is all about hitting underlying inflationary pressures.
The hawks at the ECB, including notably Isabel Schnabel at the Executive Board, have been warning about these pressures now for months, and their materialization is now coming through in spades — even in the Chief Economist’s staff economic forecast.
Bloomberg 1/9/23
European Central Bank Chief Economist Philip Lane said price pressures in the euro area will remain elevated even if surging energy costs are starting to ease.
“This is not conclusive for the overall inflation dynamic,” Lane told a panel discussion in New Orleans. The original energy shock resulting from Russia’s war in Ukraine and pandemic reopening effects will feed into wages “for the next two or three years,” he said.
Euro-area inflation slowed to 9.2% in December, more than economists had predicted, according to data released Friday. The slowdown was driven by energy, though a measure of price growth that strips out such volatile items reached a record 5.2%.
With wage increases so far falling short of these price gains, there’s now a gap that will “keep pressure on inflation for the next number of years,” Lane said.
Still, if the slowdown in energy costs persists, it should over time feed into “less pressure on food inflation, less pressure on core inflation,” Lane said. “We should recognize that but, of course, we also should recognize the uncertainty about the future path of energy prices.”
The ECB raised borrowing costs by 250 basis points last year and pledged that more hikes will follow. Simulations show that the current level of interest rates isn’t enough to return inflation to the 2% target in a timely manner, Lane said.
Bloomberg 1/9/23
The European Central Bank predicts wage
growth — a key indicator of where inflation is headed — will be
“very strong” in the coming quarters, strengthening the case for
more interest-rate hikes.
A study of salary developments since the start of the
pandemic shows underlying pay growth has been “relatively
moderate” and is currently close to its long-term trend, the
institution said Monday in an article to be published in its
Economic Bulletin.
Even so, “looking ahead, wage growth over the next few
quarters is expected to be very strong compared with historical
patterns,” it said. “This reflects robust labor markets that so
far haven’t been substantially affected by the slowing of the
economy, increases in national minimum wages and some catch-up
between wages and high rates of inflation.”
European Central Bank Chief Economist Philip Lane said price pressures in the euro area will remain elevated even if surging energy costs are starting to ease.
“This is not conclusive for the overall inflation dynamic,” Lane told a panel discussion in New Orleans. The original energy shock resulting from Russia’s war in Ukraine and pandemic reopening effects will feed into wages “for the next two or three years,” he said.
Euro-area inflation slowed to 9.2% in December, more than economists had predicted, according to data released Friday. The slowdown was driven by energy, though a measure of price growth that strips out such volatile items reached a record 5.2%.
With wage increases so far falling short of these price gains, there’s now a gap that will “keep pressure on inflation for the next number of years,” Lane said.
Still, if the slowdown in energy costs persists, it should over time feed into “less pressure on food inflation, less pressure on core inflation,” Lane said. “We should recognize that but, of course, we also should recognize the uncertainty about the future path of energy prices.”
The ECB raised borrowing costs by 250 basis points last year and pledged that more hikes will follow. Simulations show that the current level of interest rates isn’t enough to return inflation to the 2% target in a timely manner, Lane said.
Bloomberg 1/9/23
The European Central Bank predicts wage
growth — a key indicator of where inflation is headed — will be
“very strong” in the coming quarters, strengthening the case for
more interest-rate hikes.
A study of salary developments since the start of the
pandemic shows underlying pay growth has been “relatively
moderate” and is currently close to its long-term trend, the
institution said Monday in an article to be published in its
Economic Bulletin.
Even so, “looking ahead, wage growth over the next few
quarters is expected to be very strong compared with historical
patterns,” it said. “This reflects robust labor markets that so
far haven’t been substantially affected by the slowing of the
economy, increases in national minimum wages and some catch-up
between wages and high rates of inflation.”
January 3, 2023
SGH Insight
The Fed’s level of commitment to slowing growth and raising the unemployment rate will determine the path of policy and economic activity this year. I sometimes think that we fail to appreciate the depth of the Fed’s hawkishness as revealed by the December Summary of Economic Projections (SEP). On one hand, a slowing in the pace of rate hikes with the terminal rate in sight appears to be a dovish shift. But hawkishness is not really about the pace or extent of rate hikes, it’s about the willingness to endure elevated unemployment to restore price stability.
Market Validation
Fed minutes: No rate cuts in 2023, inflation risk remains in focus
Wed, January 4, 2023
No Federal Reserve officials thought it’d be appropriate to begin cutting rates in 2023, and officials worried easing financial conditions could complicate the central bank's efforts to bring down inflation, according to internal discussions at the Fed's policy meeting three weeks ago.
Minutes from the central bank's December policy meeting released Wednesday showed while Fed officials welcomed easing October inflation data, they stressed it would take substantially more evidence of progress to be confident inflation was coming down in a sustained manner.
Wed, January 4, 2023
No Federal Reserve officials thought it’d be appropriate to begin cutting rates in 2023, and officials worried easing financial conditions could complicate the central bank's efforts to bring down inflation, according to internal discussions at the Fed's policy meeting three weeks ago.
Minutes from the central bank's December policy meeting released Wednesday showed while Fed officials welcomed easing October inflation data, they stressed it would take substantially more evidence of progress to be confident inflation was coming down in a sustained manner.
December 22, 2022
SGH Insight
Final Thoughts Ahead of the Holidays
This is how I am thinking about the economy and the Fed as we approach the New Year:
The Fed is very certain it needs to loosen labor markets to prevent another year of rapid wage growth, and that requires a substantially higher unemployment rate by the end of next year. It sees wages as ultimately driving inflation, and that the current disinflation will not be sustained in 2024 if it can’t bring wage growth under control. The labor market resilience has surprised the Fed, and it believes it needs to keep tightening until it sees clear evidence that the labor market is in retreat. Only then can the Fed be confident it will bring inflation under control over the longer run.
Market Validation
This is how I am thinking about the economy and the Fed as we approach the New Year:
The Fed is very certain it needs to loosen labor markets to prevent another year of rapid wage growth, and that requires a substantially higher unemployment rate by the end of next year. It sees wages as ultimately driving inflation, and that the current disinflation will not be sustained in 2024 if it can’t bring wage growth under control. The labor market resilience has surprised the Fed, and it believes it needs to keep tightening until it sees clear evidence that the labor market is in retreat. Only then can the Fed be confident it will bring inflation under control over the longer run.
WSJ 1/5/23
Fed Officials Warn on Their Resolve
Minutes of December meeting show fear that market rallies would pressure rates upward
Federal Reserve officials offered uncharacteristically blunt words of warning to investors that cautioned against underestimating the central bank's determination to hold interest rates at higher levels to bring down inflation.
Minutes of the Fed's policy meeting last month, released Wednesday, highlighted the tricky communications task that has vexed the central bank over the past six months.
The Fed's rapid rate increases last year have fanned investors' hopes that inflation will slow quickly over the coming year. In the run-up to the December meeting, longer-term bond yields tumbled, reflecting both optimism about a speedy decline in inflation and fears of a recession this year.
But many Fed officials are anxious they won't be able to defeat inflation unless they can slow the economy by tightening financial conditions, such as by raising borrowing costs or lowering stock prices.
Any market rallies that ease financial conditions threaten to hinder officials' effort to cool hiring and wage growth. That, in turn, could prompt them to continue lifting rates or holding them at higher levels for longer, increasing the risk of a deeper or longer economic downturn.
Fed Officials Warn on Their Resolve
Minutes of December meeting show fear that market rallies would pressure rates upward
Federal Reserve officials offered uncharacteristically blunt words of warning to investors that cautioned against underestimating the central bank's determination to hold interest rates at higher levels to bring down inflation.
Minutes of the Fed's policy meeting last month, released Wednesday, highlighted the tricky communications task that has vexed the central bank over the past six months.
The Fed's rapid rate increases last year have fanned investors' hopes that inflation will slow quickly over the coming year. In the run-up to the December meeting, longer-term bond yields tumbled, reflecting both optimism about a speedy decline in inflation and fears of a recession this year.
But many Fed officials are anxious they won't be able to defeat inflation unless they can slow the economy by tightening financial conditions, such as by raising borrowing costs or lowering stock prices.
Any market rallies that ease financial conditions threaten to hinder officials' effort to cool hiring and wage growth. That, in turn, could prompt them to continue lifting rates or holding them at higher levels for longer, increasing the risk of a deeper or longer economic downturn.
November 14, 2022
SGH Insight
Bank of Japan Governor Haruhiko Kuroda has initiated a gradual and calculated handover to his successor by softening the path to an eventual exit from ultra easy monetary policy, including specifically Yield Curve Control (YCC), which officials envisage they can accomplish by mid next year.
The complex timeline for transition is expected to navigate policy through a seamless hand off in the central bank leadership, and it is also hoped a modification to policy will be made smoother if it coincides with a pause in the US tightening cycle to minimize the potential disruption to the global and domestic rates markets.
Last month BOJ policymakers acknowledged in a summary of their meeting that they would intensify internal work on the side effects of prolonged easing and the impact of a future exit from easy conditions.
The shift reflects the extent of interagency coordination and behind-the-scenes planning for an eventual change in policy. Kuroda will likely continue to hint at planning efforts to exit YCC before a December succession announcement so that his successor can then start publicly describing the plans.
Market Validation
The complex timeline for transition is expected to navigate policy through a seamless hand off in the central bank leadership, and it is also hoped a modification to policy will be made smoother if it coincides with a pause in the US tightening cycle to minimize the potential disruption to the global and domestic rates markets.
Last month BOJ policymakers acknowledged in a summary of their meeting that they would intensify internal work on the side effects of prolonged easing and the impact of a future exit from easy conditions.
The shift reflects the extent of interagency coordination and behind-the-scenes planning for an eventual change in policy. Kuroda will likely continue to hint at planning efforts to exit YCC before a December succession announcement so that his successor can then start publicly describing the plans.
Bloomberg 12/20/22
Bank of Japan Governor Haruhiko Kuroda just
gave investors a glimpse of what to expect when the world’s
boldest experiment with ultra-loose monetary policy comes to an
end.
In the face of sustained market pressure, Kuroda shocked
markets Tuesday by saying he’ll now allow Japan’s 10-year bond
yields to rise to around 0.5%, double the previous upper limit
of 0.25%.
Whether this is a strategic tweak to buy time for his
yield-curve control settings until his decade-long term ends in
April or the start of the end for his unprecedented monetary
easing remains to be seen.
But one thing is clear: a crack has opened that markets
around the world will keep prising in the weeks and months
ahead.
“This is a step toward an exit, whatever the BOJ calls it,”
said Masamichi Adachi, chief Japan economist at UBS Securities
and a former BOJ official. “This opens the door to a chance of a
rate hike in 2023 under a new governorship.”
Bank of Japan Governor Haruhiko Kuroda just
gave investors a glimpse of what to expect when the world’s
boldest experiment with ultra-loose monetary policy comes to an
end.
In the face of sustained market pressure, Kuroda shocked
markets Tuesday by saying he’ll now allow Japan’s 10-year bond
yields to rise to around 0.5%, double the previous upper limit
of 0.25%.
Whether this is a strategic tweak to buy time for his
yield-curve control settings until his decade-long term ends in
April or the start of the end for his unprecedented monetary
easing remains to be seen.
But one thing is clear: a crack has opened that markets
around the world will keep prising in the weeks and months
ahead.
“This is a step toward an exit, whatever the BOJ calls it,”
said Masamichi Adachi, chief Japan economist at UBS Securities
and a former BOJ official. “This opens the door to a chance of a
rate hike in 2023 under a new governorship.”
December 15, 2022
SGH Insight
Bottom Line: If the Fed didn’t like yesterday’s market response, we are going to start hearing about it. I don’t know, however, that market participants will react to jawboning given the view that the next few inflation numbers will be soft. They might need to see Baoard members coming out in favor of another 50bp rate hike before absorbing that message. Even then, what market participants really need is data to support the Fed’s projected policy path, and that will take time.
Market Validation
Bloomberg 12/16/22
Fed Officials Reinforce Hawkish Message on Need for Higher Rates
Federal Reserve officials, hammering home an
unapologetically hawkish message, said that they won’t relent on
tighter policy until inflation is under control.
New York Fed President John Williams and San Francisco Fed
chief Mary Daly both stressed the central bank’s commitment to
lowering inflation back to their 2% target and the need for
clear evidence of easing price pressures.
“We’re going to have to do what’s necessary,” Williams said
Friday during an interview on Bloomberg Television with Kathleen
Hays.
Referring to the central bank’s forecast that rates will
peak above 5% next year, he said “it could be higher than what
we’ve written down” if that’s what it takes reduce inflation.
Fed Officials Reinforce Hawkish Message on Need for Higher Rates
Federal Reserve officials, hammering home an
unapologetically hawkish message, said that they won’t relent on
tighter policy until inflation is under control.
New York Fed President John Williams and San Francisco Fed
chief Mary Daly both stressed the central bank’s commitment to
lowering inflation back to their 2% target and the need for
clear evidence of easing price pressures.
“We’re going to have to do what’s necessary,” Williams said
Friday during an interview on Bloomberg Television with Kathleen
Hays.
Referring to the central bank’s forecast that rates will
peak above 5% next year, he said “it could be higher than what
we’ve written down” if that’s what it takes reduce inflation.
December 15, 2022
SGH Insight
European Central Bank hawks may have lost a skirmish when the Governing Council decided, as widely expected, to de-normalize the “jumbo” 75 bp rate hike pace of the last two meetings and hike interest rates today by 50 bps, taking the benchmark deposit rate to 2.0%.
But they won the war, in a major way, as ECB President Christine Lagarde came out guns blazing with the message that the ECB has “significantly” more wood to chop on rate hikes, and that all the market assumptions around the 3% or so end point for this rate hike cycle, with some of the doves and market participants even eyeing as low as 2.5%, will need to be revised up — by a lot.
And while Lagarde did not place a number on that elusive “terminal rate,” we believe, as we wrote in SGH 11/30/22, “ECB: A Major Disconnect with Markets,” that means the ECB is increasingly eyeing a 3.5%-4% landing zone when all is said and done.
Market Validation
But they won the war, in a major way, as ECB President Christine Lagarde came out guns blazing with the message that the ECB has “significantly” more wood to chop on rate hikes, and that all the market assumptions around the 3% or so end point for this rate hike cycle, with some of the doves and market participants even eyeing as low as 2.5%, will need to be revised up — by a lot.
And while Lagarde did not place a number on that elusive “terminal rate,” we believe, as we wrote in SGH 11/30/22, “ECB: A Major Disconnect with Markets,” that means the ECB is increasingly eyeing a 3.5%-4% landing zone when all is said and done.
Bloomberg 12/16/22
Traders Raise Peak Rate Bets After Further Hawkish ECB Comments
Money markets are betting the ECB will lift
the deposit rate as high as 3.36% after policy maker Olli Rehn
adds his voice to calls for more tightening.
* Traders price 89bps of rate hikes by March and add as much as
17bps to peak rate wagers after Rehn says rates are likely to
rise by 50bps in February and March and is not convinced markets
are pricing the terminal rate correctly
** Earlier, policy maker Muller said rates will need to raised
further while Villeroy said rates will rise as much as necessary
Traders Raise Peak Rate Bets After Further Hawkish ECB Comments
Money markets are betting the ECB will lift
the deposit rate as high as 3.36% after policy maker Olli Rehn
adds his voice to calls for more tightening.
* Traders price 89bps of rate hikes by March and add as much as
17bps to peak rate wagers after Rehn says rates are likely to
rise by 50bps in February and March and is not convinced markets
are pricing the terminal rate correctly
** Earlier, policy maker Muller said rates will need to raised
further while Villeroy said rates will rise as much as necessary
November 30, 2022
SGH Insight
There is a major disconnect between market expectations and pricing, and the policy rate European Central Bank officials increasingly feel will be needed to bring inflation back down to their 2% target.
Markets have for some time converged, and remain converged, around a 3% “terminal rate” for this hiking cycle, pricing it today at around 2.8% after the drop in eurozone headline inflation readings from 10.6% in October to 10.0% in November.
As things stand, however, the ECB is likely to raise rates into the 3.5% to 4.0% range next year and look to keep them there for a while to bring inflation back down to target...
...Similarly, while analysts are keenly focused on the interplay and political tradeoffs between the start of the ECB’s balance sheet reduction and magnitude of the next interest rate hike, that kind of fine tuning of policy is now a bit of a red herring.
We expect that the ECB will not dally around with a previously planned, and widely expected, two-step process of rolling out the broad contours for shrinking its balance sheet on December 15, to be agreed and implemented at their subsequent meeting in February (some analysts are expecting even later than that).
We expect the ECB will move forward imminently with its balance sheet reduction program, and will agree, announce, and roll out the details of that program at its upcoming December 15 meeting, to take effect as soon as feasible...
Market Validation
Markets have for some time converged, and remain converged, around a 3% “terminal rate” for this hiking cycle, pricing it today at around 2.8% after the drop in eurozone headline inflation readings from 10.6% in October to 10.0% in November.
As things stand, however, the ECB is likely to raise rates into the 3.5% to 4.0% range next year and look to keep them there for a while to bring inflation back down to target...
...Similarly, while analysts are keenly focused on the interplay and political tradeoffs between the start of the ECB’s balance sheet reduction and magnitude of the next interest rate hike, that kind of fine tuning of policy is now a bit of a red herring.
We expect that the ECB will not dally around with a previously planned, and widely expected, two-step process of rolling out the broad contours for shrinking its balance sheet on December 15, to be agreed and implemented at their subsequent meeting in February (some analysts are expecting even later than that).
We expect the ECB will move forward imminently with its balance sheet reduction program, and will agree, announce, and roll out the details of that program at its upcoming December 15 meeting, to take effect as soon as feasible...
Bloomberg 12/15/22
*LAGARDE: ECB NEEDS TO DO MORE ON RATES THAN MARKETS PRICE
*LAGARDE: MARKET RATE BETS DON'T ALLOW ECB TO REACH 2% GOAL
*LAGARDE: ANYONE THINKING ECB IS PIVOTING IS WRONG
Yet more tough language from Lagarde as she again flags the possibility of several 50 basis points hikes. It shouldn’t be regarded as the new normal, but in current circumstances it’s the right approach, she says. “We need to take this fight and continue the battle against inflation.”
In response to Alex’s first question whether 3% is a fair assumption for a terminal rate, Lagarde says that staff projections do not allow a return to 2% inflation target in a timely manner. More needs to be done and as a result new market expectations will “hopefully” be embedded in future projections, she says.
12/15/22 ECB Monetary policy statement
The key ECB interest rates are the Governing Council’s primary tool for setting the monetary policy stance. The Governing Council today also discussed principles for normalising the Eurosystem’s monetary policy securities holdings. From the beginning of March 2023 onwards, the asset purchase programme (APP) portfolio will decline at a measured and predictable pace, as the Eurosystem will not reinvest all of the principal payments from maturing securities. The decline will amount to €15 billion per month on average until the end of the second quarter of 2023 and its subsequent pace will be determined over time.
*LAGARDE: ECB NEEDS TO DO MORE ON RATES THAN MARKETS PRICE
*LAGARDE: MARKET RATE BETS DON'T ALLOW ECB TO REACH 2% GOAL
*LAGARDE: ANYONE THINKING ECB IS PIVOTING IS WRONG
Yet more tough language from Lagarde as she again flags the possibility of several 50 basis points hikes. It shouldn’t be regarded as the new normal, but in current circumstances it’s the right approach, she says. “We need to take this fight and continue the battle against inflation.”
In response to Alex’s first question whether 3% is a fair assumption for a terminal rate, Lagarde says that staff projections do not allow a return to 2% inflation target in a timely manner. More needs to be done and as a result new market expectations will “hopefully” be embedded in future projections, she says.
12/15/22 ECB Monetary policy statement
The key ECB interest rates are the Governing Council’s primary tool for setting the monetary policy stance. The Governing Council today also discussed principles for normalising the Eurosystem’s monetary policy securities holdings. From the beginning of March 2023 onwards, the asset purchase programme (APP) portfolio will decline at a measured and predictable pace, as the Eurosystem will not reinvest all of the principal payments from maturing securities. The decline will amount to €15 billion per month on average until the end of the second quarter of 2023 and its subsequent pace will be determined over time.
December 9, 2022
SGH Insight
The United Kingdom’s ongoing battle with inflation is likely to see the Bank of England (BOE) raise rates 50 basis points to 3.5% at next week’s meeting despite concerns that tighter policy threatens to deepen a looming recession.
The UK has the most to do among the major central banks but also faces the greatest risk of recession. The BOE raised rates 75bp in November as inflation continued to surge higher than officials expected. It has raised rates eight times in the past year to 3% in an effort to avert a wage-price spiral.
At the time of the November meeting the BOE’s chief economist Huw Pill indicated there was more work to do to guide prices back to the Bank’s mandated 2% target over time. UK inflation is running at 11.1% – five times the target.
Governor Andrew Bailey’s proposal to the December 15 meeting will likely draw at least two dissents from committee members. One will be from Silvana Tenreyro who has consistently fought larger increments through the central bank’s tightening cycle. Also, the Bank’s latest addition to the committee this year, Swati Dhingra argued in an interview published on Saturday that higher interest rates could lead to a deeper and longer recession.
Dhingra believes there are few signs that demands for higher wages risk a wage-price spiral. In contrast others on the committee like external BOE rate setter Catherine Mann worry about what she sees as higher inflation expectations already having become embedded into psychology. Mann wants rising inflation dynamics stamped with larger moves to avoid the Bank having to inflict greater pain via a severely restrictive policy setting later.
Market Validation
The UK has the most to do among the major central banks but also faces the greatest risk of recession. The BOE raised rates 75bp in November as inflation continued to surge higher than officials expected. It has raised rates eight times in the past year to 3% in an effort to avert a wage-price spiral.
At the time of the November meeting the BOE’s chief economist Huw Pill indicated there was more work to do to guide prices back to the Bank’s mandated 2% target over time. UK inflation is running at 11.1% – five times the target.
Governor Andrew Bailey’s proposal to the December 15 meeting will likely draw at least two dissents from committee members. One will be from Silvana Tenreyro who has consistently fought larger increments through the central bank’s tightening cycle. Also, the Bank’s latest addition to the committee this year, Swati Dhingra argued in an interview published on Saturday that higher interest rates could lead to a deeper and longer recession.
Dhingra believes there are few signs that demands for higher wages risk a wage-price spiral. In contrast others on the committee like external BOE rate setter Catherine Mann worry about what she sees as higher inflation expectations already having become embedded into psychology. Mann wants rising inflation dynamics stamped with larger moves to avoid the Bank having to inflict greater pain via a severely restrictive policy setting later.
Bloomberg 12/15/22
The Bank of England raised interest rates for a ninth time in a row to a 14-year high of 3.5%, pressing ahead with efforts to tame sky-high inflation.
The nine-member Monetary Policy Committee split three ways on the decision as officials tried to balance the risk of inflation getting entrenched against squeezing too hard on growth just as the economy enters a recession.
Six members including Governor Andrew Bailey voted for the half-point rise. Catherine Mann favored three-quarters of a point, while Silvana Tenreyro and Swati Dhingra backed leaving rates unchanged.
The Bank of England raised interest rates for a ninth time in a row to a 14-year high of 3.5%, pressing ahead with efforts to tame sky-high inflation.
The nine-member Monetary Policy Committee split three ways on the decision as officials tried to balance the risk of inflation getting entrenched against squeezing too hard on growth just as the economy enters a recession.
Six members including Governor Andrew Bailey voted for the half-point rise. Catherine Mann favored three-quarters of a point, while Silvana Tenreyro and Swati Dhingra backed leaving rates unchanged.
News and Events
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