To be sure, there’s something comical about the juxtaposition between this idea that DM central bankers are trying their best to “carefully” telegraph an exit from crisis-era policies and the hair-on-fire, mad dash to coordinate a hawkish message that we’ve seen since Draghi’s comments in Sintra, Portugal on June 27.
As noted earlier today, they’re trying to micromanage this by the hour (that’s the “careful” telegraphing) but really, you need only look at a one-month chart of DM bond yields to see why it’s tempting to call this a rather ham-handed effort:
So far, that hasn’t translated into the kind of equity weakness you might imagine would accompany a “tantrum” but the jury is still out – remember, this has only been going on for three weeks. That is, try to extrapolate from that chart what yields are going to look like in a year if they don’t figure out how to get the messaging “right.”
Of course behind all of this is an implicit (and increasingly explicit) desire to curb excessively loose financial conditions at the possible expense of inflation.
Well, because it’s literally impossible to overstate how important this whole dynamic truly is (and there are a whole lot of vol. sellers and carry traders that are going to get a wake up call here pretty soon), here’s some useful color from Citi out Thursday in a note called “Are AE Central Banks Coordinating To Turn Hawkish“…
In recent weeks, statements by a number of Advanced Economy (AE) central banks (including the BoC, BoE, ECB and Fed) have appeared to be more ‘hawkish’ than previously, suggesting that there was a shift in central bank attitudes and that perhaps some of this hawkish turn may be coordinated. We had previously pointed to faster-than-expected monetary tightening as one of the risks for this year’s outlook and recently reiterated that AE central banks have become more patient and confident.
We argue that a shift in central bank attitudes is indeed taking place and that there are a number of common themes across AE central banks, including more confidence about the inflation outlook and the resilience of financial markets. These parallels overall suggest that central banks will be more hawkish in the sense that they would be less willing to react to (modest) inflation undershoots with additional easing and that the hurdle to tighten policy is falling.
We stress that monetary conditions overall remain accommodative across AEs and are likely to remain so and any forthcoming tightening is likely to be gradual (particularly compared to past cycles, Figure 2): overall, we only expect average AE policy rates to rise by 12bp by year-end and 50bp by end-18 and therefore real interest rates only rising very modestly. We also think that even though the recent hawkish tilt could be reversed, we suspect that at least in some cases (notably the ECB and the BoJ, but perhaps also the Fed) central banks may be slow to react to any potential signs of falling inflation, raising the risk of policy mistakes.
In our view, there are a number of common policy-relevant themes across AE central banks currently that underlie the recent changes in rhetoric, notably:
1. Less fear of disinflation/deflation. In our view, this is due to i) higher realized inflation (average AE headline inflation in May was at 1.4%, up from a recent low of 0.2% in September 2015 and 0.7% in 2016, Figure 4) and ii) an expectation that low unemployment rates and continued above-potential growth would push inflation higher, ie some residual confidence that Phillips curve relationships still apply, even if slower than in the past. The average AE unemployment rate is at 5.9% as of May, the lowest since April 2008 (Figure 5). Several ECB speakers refer to the fact that financial markets appear to have mainly priced out deflation in the Eurozone, for instance, while ECB President Draghi, among others, has now variously noted that deflation risks have been banished.
2. Financial market resilience. Central banks are likely to be encouraged by the sense that economies/financial systems appear somewhat resilient to moderate monetary tightening. Indeed, NY Fed President Dudley noted recently that “When financial conditions ease,…this can provide additional impetus for the decision to continue to remove monetary policy accommodation.”
3. The limit(ation)s of monetary policy. In our view, a number of AE central banks are aware that they are relatively close to being out of ammunition, if faced with undershoots of inflation. In addition, there seems to be a growing realization that monetary policy may not be effective in raising inflation quickly, even if it would raise inflation eventually. This argument is more relevant for central banks that may otherwise be easing policy (such as the ECB or perhaps the BoJ) rather than those that are considering tighter policy (Fed, BoE or BoC). These changing attitudes were very apparent from the shift in the BoJ’s approach in 2016, when it introduced its yield-targeting policy. Since then, it appears that as long as inflation is still rising, the BoJ may not try to ease policy further, even if it continues to undershoot its own forecasts (and remains far away from its 2% target). We similarly interpret the recent rhetoric by the ECB as suggesting that the ECB is less focused than it was in the recent past on potential undershoots of inflation relative to its forecasts.