Not For Me To Say

“Not for me to say.”

That was Christine Lagarde’s assessment Thursday when, following the October ECB decision, she endeavored to contextualize market expectations for rate hikes. “Our analysis certainly does not support that the conditions of our forward guidance are satisfied at the time of liftoff as expected by markets, nor any time soon thereafter,” she remarked, before refusing to say, definitively, whether markets are “ahead of themselves.”

That Lagarde declined to speak on behalf of markets was notable. It again suggested central banks may be attempting to sever the link — to let markets interpret the situation as traders see fit, but not necessarily allowing that interpretation to inform internal policy deliberations. I talked about this at length on Wednesday following the front-end shock delivered by the Bank of Canada’s hawkish turn and the ongoing drama in Aussie rates.

Vassilis Karamanis, an FX and rates strategist who writes for Bloomberg, picked up a version of the narrative on Friday. “I do see the need for forward guidance, don’t get me wrong. It’s been with us for years and some market participants cannot do without it,” Karamanis wrote. “But we have reached the point where we don’t need someone to hold our hand as we cross the street. It’s time we do it on our own.”

You could argue that central banks are, in fact, listening to markets, which are telling them that rate hikes are appropriate. But it doesn’t feel like traders are very comfortable. Rather, it feels like they’re flying blind, as evidenced by the 15-sigma move in the Canadian front-end Wednesday and the dramatic repricing in the Aussie curve as the RBA abandoned YCC without “asking.”

In other words, markets are pricing in tighter policy, but they still seem taken aback by what feels like insufficiently telegraphed pivots. Lagarde’s remarks were described as “half-hearted,” but as Karamanis suggested in his Friday piece, “half-hearted” in this context really means too vague. Lagarde effectively told the market to do as it pleases — that market pricing (which, by Friday, penciled in 20bps of ECB tightening in October of 2022) is irrelevant to policymakers.

“According to officials familiar with the matter, policymakers were cautious about an outright pushback on rate hikes backfiring, given the high uncertainty around the outlook,” Karamanis went on to write, before posing two questions: “Does it also mean that the Governing Council isn’t so sure about their transitory narrative after all? Or that markets have more of a carte blanche to bet their own way?”

Probably both. And also that whichever way markets bet, the ECB will take its own decisions on the matter. This could mean the two-way communication loop whereby all incoming data was interpreted as somehow consistent with easier policy, a consensus between markets and policymakers that almost always manifested in benign forward guidance and market-friendly outcomes, is dead.

On Friday, data showed the eurozone economy performed better than expected in the third quarter, growing 2.2%, a touch higher than the 2.1% economists expected. But it scarcely mattered. Or at least not for the headline writers. Because the flash read on inflation for October was much hotter than expected. CPI rose 4.1% YoY, nearly matching the highest estimate from three-dozen economists (figure below). Consensus was 3.7%.

Core was 2.1%, breaching the 2% threshold for the first time in decades.

“With inflation above 4% and core inflation above 2%, the breeding ground for second round effects on inflation becomes more fertile,” ING’s Bert Colijn said. “Whether it is fertile enough for inflation to turn structural remains to be seen, but the ECB will have to keep a close eye on it.”

Although the ECB is still sticking mostly to the script in terms of predicting an eventual moderation in price pressures, Lagarde conceded that inflation “will last longer than originally expected.”

Respondents to the ECB’s survey of professional forecasters lifted their inflation outlook to 2.3% for this year, 1.9% for next and 1.7% for 2023, results released Friday showed.

HSBC’s global head of fixed income research, Steven Major, described a tug of war in the bond market. “The long-end is telling us there’s a growth scare,” he said, during remarks to Bloomberg. “The inflation linked markets are sort of goading central banks to hike.”

As far as the scope of any tightening, Major said “they won’t go very far [and] won’t get anywhere near the peak from the previous cycle.”

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