By Peter De Coensel,
Member Management Board at DPAM


The New Zealand Central Bank (RBNZ) raised the cash rate from 0.25% to 0.50% on Thursday. The RBNZ projects policy rates to reach 2.00% by the end of 2023. Over that horizon, the market-implied policy rate sits at 1.75%. 10-year rates finished the week at 2.12%, a year-to-date high. Of late, demand for AAA New Zealand Government bond paper has been sound and the kiwi dollar has been behaving in a highly-rangebound manner. An interesting set of conditions for a quality diversifier. We also get a sneak preview of how long-term bonds behave the moment an interest rate hiking cycle kicks-off.

The Polish Central Bank surprised many by hiking 40bp towards a 0.50% policy rate as inflation printed at 5.8%. Poland joins the Hungarian and Czech Central Bank in putting liquidity brakes in place. Interestingly, the Peruvian and Russian Central Banks also decided to tighten financial conditions.

The inflation narrative has clearly led to a pre-emptive reaction function across many second and third tier central banks. Emerging Market (EM) Central Banks seek to nurture their credibility and must fight unanchoring inflation expectations. It’s their weak spot. But what happens when Developed Market Central Banks also join, as has been the case of late? The idea I want to launch is that the order of action has been reversed. It was the FED that initiated large-scale asset-purchase programs in late 2008. The BoJ, the BoE and the ECB followed suit over the next 7 years. It took a global pandemic for second and third tier central banks to engage in similar unconventional policy actions. New Zealand and Australia adopted explicit yield curve control actions. Many EM central banks engaged in QE experiments. It becomes clear that a Last In First Out (LIFO) principle is adhered to.

Effectively, the FED and the ECB have the comfort to wait for longer before engaging in tapering QE programs or departing from the zero or negative lower bound. High frequency economic indicators reveal that Q3 and Q4 might underdeliver on growth. Peak-growth conditions might have occurred over H1, 2021. Such a result might receive confirmation over the coming week as the IMF annual gathering takes place. They will indeed deliver growth and inflation forecasts over 2022 and 2023, confirming, most probably, that inflation is set to peak over Q4 but lose steam towards the middle of 2022. The Washington-based institution will join the FED in repeating the ‘transitory inflation’ narrative.

Nevertheless, market-based US inflation expectations reveal worry even though they rose swiftly over the past week. 10-year US breakeven rates passed resistance to close at 2.51%. We are still in tactical territory. As mentioned last week, a test of 2.75% might be in the cards as was the case over the 2004-2005 inflation ‘scare’. The risk-scenario sits in a firm and sudden push through a 15-year high, attempting the 3.00% threshold. That should unnerve the FED. Such was the case this week for UK inflation-linked Gilts. UK 10-year inflation expectations breached 4.00%. A level seen in early 2008 and between 1994 and 1996. The message is clear. These are rare circumstances. The Bank of England spoke aggressively afterwards, informing markets that every monetary policy meeting would be live going forward. ’Live’, meaning a rate hike might result.

Yet. Such menace lacks credibility. It feels as if central banks have been broadening their communication tool set and decided to take a more aggressive language in order to depress inflation expectations.

Second and third tier central banks can do some heavy lifting and tighten financial conditions at the edges of the financial system. Such an outcome would buy time for G4 central banks.

G4 monetary authorities do not fear second round salary pressures as inflation eats away consumer purchasing power. Countries that apply automatic salary indexation might see and accept government budgets outside acceptable ranges for longer. Fact is that political leadership is not worried whatsoever. They are creative and invent costly short-term measures in order to seek goodwill with the electorate. In France, freezing energy pricing springs to mind. Nation-wide winter energy allowances to families in need is another political capital building measure that passed the papers this week. First year students in economics learn that price controls lead to worse longer-term outcomes as demand-supply imbalances are kept artificially in place. Such political attitudes might be the real similarity with the inflation in the 1970s.

Expect G4 central banks to provide top support to fiscal authorities for as long as possible. The moment G4 central banks act pre-emptively as smaller central banks do today, we’ll have a recession narrative that becomes dominant overnight. Before long, the inflation narrative will be replaced by a recession narrative. The latter does not please the political leadership. Expect the inflation debate to linger over H1 2022.


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