This Week, We Saw A “Startling Transformation”

On Friday, anyone long risk learned they still have one reliable central banker friend: Haruhiko Kuroda.

As detailed earlier this morning, the BoJ dispelled the notion that they’re contemplating an exit strategy and even if they are, Kuroda quite literally said it’s not appropriate to show you what it is right now.

That was good enough for most global equity benchmarks and predictably, it sent the yen lower against all its G-10 peers.

But Peter Pan notwithstanding, what we got this week underscored the notion that the days of calling central bankers’ bluffs when they lean any semblance of hawkish may be coming to an end. This is something we discussed at length last week in “Josephine Witt’s Reign Is Over Or, Central Banks May Actually Mean It This Time.”

Indeed, the Fed seemed largely undeterred by Wednesday’s lackluster data in the US. Curbing speculation by leaning against loose financial conditions seems to have taken precedence over combatting the readily apparent deflationary impulse.

Here with more on why this week marked a “startling transformation in the reaction function of some major central banks,” is Bloomberg’s Cameron Crise.

Via Bloomberg

This week has seen an apparently startling transformation in the reaction function of some major central banks. After years of surprising on the dovish side, the Fed and Bank of England were both more hawkish than expected over the past couple of days. This in turn may have consequences for markets accustomed to a perennial central bank backstop.

  • One of the most powerful arguments for the rising tide of global assets in recent years has been the seemingly inexorable dovish tilt of monetary authorities. It’s always easy to buy the dip when your local central banker has your back.

CBsStocks

  • This week, however, has provided clear evidence that global policy currents have shifted. It would have been unthinkable a year or two ago for the Fed to hike rates while at the same time at least partially dismissing a string of disappointing inflation figures. Yet that’s exactly what happened on Wednesday.
  • The Fed’s decision supports the notion that they are focused on achieving a certain level for the Fed funds rate rather than assessing the arguments for each marginal change. While they should eventually revert back to a changes model, as long as the apparent FOMC focus remains on levels then the policy bias will be hawkish relative to recent historical norms.
  • It is telling that expectations for another rate hike this year have already more or less completely reversed the sharp decline observed after Wednesday’s poor CPI data.
  • On Thursday the Bank of England stunned markets by revealing that it nearly hiked rates, retaining an unchanged policy setting by a 5-3 margin. This was unexpected coming on the heels of generally poor growth data and suggests that the Bank’s orientation has shifted very much toward the risks posed by high inflation. Short-term yields soared as equities suffered.
  • This week the Bank of Canada power structure has also suggested that it may be closer to a rate hike than the market had supposed.
  • While Friday’s BOJ meeting may be slightly premature for an upgrade to the economic outlook, it seems like only a matter of time before it happens. That in turn will be taken as a signal that an asset-purchase taper is coming. A fixed income selloff looks almost inevitable when that occurs.
  • A hawkish tilt for central banks against lower inflation (excluding the U.K.) is a natural recipe for a rise in real yields. We’ve already seen that in the U.S., which has helped propel the dollar higher.
  • Coming on the heels of stellar performance for risky assets such as tech stocks and emerging markets, a rise in real yields offers an increasingly compelling argument for fund managers to take some risk off the table.
  • There are never any guarantees that X will beget Y, of course. But it’s a fund manager’s job to assess the balance of probability when taking investment decisions. With many risky assets close to the ding-dong highs and central bankers becoming less supportive, it’s hard to argue that conditions are as favorable as they were a few months ago.
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