At Stake This Week: Credibility

The November FOMC meeting and accompanying taper announcement will garner most of the financial headlines in the new week.

But market participants will be watching the RBA and the BoE intently.

Much of the global drama in rates since late September can be traced, in one way or another, to the UK, where rate hike bets and expectations for reduced issuance flattened the curve dramatically (figure below).

Recall that the genesis of the global upheaval in rates dates to September 23, the day after the September FOMC when, hours after the Norges Bank became the first central bank to raise rates in the pandemic era among countries with the 10 most-traded currencies, a hawkish BoE statement set in motion the dynamics that brought us to where we are today.

Things escalated materially on October 18, after comments from Andrew Bailey triggered a dramatic bout of bear flattening in gilts. Policymakers are staring down an impossible conjuncture as virus cases remain elevated, along with inflation. At one point in October, 10-year breakevens in the UK touched 4.25%, the highest since 1996. (For context, it wasn’t until 1997 that the BOE gained operational independence to pursue price stability.)

All of that makes Thursday’s BoE meeting critical. Following Bailey’s remarks that the bank “will have to act,” markets penciled in rate hikes for November and December. “The fate of a potential Bank of England interest increase rate on Thursday could lie in the hands of two deputy governors who have stayed silent during the crescendo of bets for an imminent move,” Bloomberg wrote, in a useful preview. With the MPC split, “the balance of power [is] in the hands of Ben Broadbent and Jon Cunliffe, who haven’t spoken in public recently about rates,” the same linked article noted.

“If not November, a December hike is nearly a done deal,” TD’s James Rossiter and Pooja Kumra wrote. “Back-to-back [hikes] in November and December [are] certainly a possibility [and] based on current pricing, it’s not the hike itself but the BoE’s rhetoric on tightening that will be key,” they added, before saying that “if they skip this meeting, expect to see a very strong rally across the board, led by the reds.”

“Markets fully expect a 15bps rate hike at the November meeting, and they’re unlikely to be left disappointed,” ING wrote, in their preview. “Waiting until December’s meeting would buy time for more data to come through, but it would also mean that policymakers lack new forecasts to help explain their move to the public, something the Bank takes seriously,” the same note said.

Meanwhile, the RBA’s credibility is on the line. Last week, the bank simply stepped aside and allowed the proverbial barbarians to breach the yield-curve control gates. The yield on the April 2024 YCC note soared to eight times the target (figure below).

“What’s the point of having the target if you don’t defend it?” wondered Diana Mousina, senior economist at AMP Capital Investors, who spoke to Bloomberg.

The problem started in earnest last Wednesday, when a hot quarterly inflation print (figure below) reinforced expectations for rate hikes far sooner than Philip Lowe’s timeline. Then, on Thursday, things escalated into “mayhem.”

By Friday, when the bank again declined to defend the YCC target, it was obvious that a policy pivot of some sort was in the offing.

Three-year yields rose the most since 1994 in October. Last week was, for lack of a more apt description, a taper tantrum in Australia.

One way or another, the RBA has some explaining to do this week. In addition to addressing what, exactly, they plan to do with YCC, Lowe will have to square his contention that rates aren’t likely to rise until 2024 with the market’s view, which is now laughably out ahead of him.

As much attention as the Fed taper will invariably receive, there’s arguably more market-moving potential in the RBA and BoE meetings.

Will it be more “napalm” and confirmation that central banks are, in fact, prepared to deploy preemptive rate hikes and abrupt policy pivots to beat back inflation at the risk of stifling growth?

If so, market participants who, for a dozen years, have been conditioned to expect transparency and vol-suppressing forward guidance, will be compelled to ponder a shift in established behavioral patterns.

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