ECB – Behind the curve.
At the October meeting, the ECB looked way behind the curve. While the statement was uneventful, communication on inflation and rates ended up delivering a weak message to markets. Lagarde has started her remarks with a deep analysis of inflation, recognizing that many factors that looked transitory now look much less so. At the same time, she has minimized the necessity for rate hikes over the next 12 months, pointing to market pricing as “wrong”. No plan was mentioned for purchase programs. Inflation concerns and pushback on hikes do not go well together, and markets went in “challenge mode” vs the ECB. During the meeting, European curves and spreads widened, with the pricing of hikes turning more aggressive. The market now prices one hike by end 2022 and three by end 2023. Higher rates despite dovish guidance points to markets now being at mercy of inflation prints. In the current global environment, this means higher rates and steeper curve, with a soon read-across over credit instruments.
Fed – Time to taper.
On Wednesday, the Fed will announce the start of tapering, after 18 months of sustained asset purchases. Starting in November, the Fed will slow down purchase (currently $120bn a month) by $15bn a month, of which $10bn in Treasuries. The pace is set to accelerate to bring purchases down to zero in mid-2022, though communication around the end date may remain flexible. Powell is likely to clarify that hikes should not be expected just because tapering starts, effectively pushing them back to 2023. The inflation outlook and supply constraints will also be a relevant part of the discussion. The start of tapering has been well anticipated by Fed speakers, and won’t come as a surprise to markets. The key aspect will have to do with communication, and Powell will need to try hard in avoiding the same mistakes made by Lagarde last week. We continue to see more room for US rates, but less curve steepening compared to Europe given a likely more aggressive policy response to inflation.
Other Central Banks – Hawks at the horizon.
Outside Europe and the US, large countries central banks continue to push towards a more hawkish stance quickly. Last week, the Bank of Canada announced tapering of QE and started guiding for hikes in early 2022. In Australia, the Reserve Bank of Australia (RBA) is not defending its yield target amid the strong inflation uptick, suggesting a change in stance at this week meeting. In emerging markets, Russia and Brazil are pushing the accelerator, respectively, with 75bp and 150bp hike over the past week. Basically, central banks with lower “global” responsibilities are recognizing the dangers of inflation, and budging to the fact that it’s not self correcting. In previous cycles (2013 and 2018), major central banks have been leading. Earlier moves outside US and Europe, in our view, suggest the Fed and ECB windows to tighten is closing up quickly.
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