For the first time since the emergence of the Omicron variant, money markets bet on a 10bps rate hike from the ECB in September.
That tidbit, extracted from Monday’s reel, was notable. Prior to the pandemic, Europe was well on its way to joining Japan in a disinflationary quagmire. Like the BoJ, the ECB appeared lost in monetary Neverland, condemned to perpetual easing in a futile effort to hit an unreachable target.
You could argue that’s still the most likely scenario. And Christine Lagarde does have a more plausible claim on the “transitory” description of price pressures than Jerome Powell. Nevertheless, inflation in Europe surged well above target last year (figure below), prompting at least some officials to insist the ECB should be more aggressive (and more preemptive).
Some say an abrupt hawkish pivot from the ECB is one of 2022’s most underappreciated risks. That comes with the obligatory caveat that “some say” is a lot like Donald Trump’s “a lot of people are saying.” “Some” usually means one or two or, at most, three. Just like “a lot of people” usually just meant Larry Kudlow.
Jokes aside, the math may not add up anymore for Lagarde. “Inflation YoY in the US, UK and Europe is currently 7%, 5% and 5%,” BofA’s Michael Hartnett said, on the way to observing that “if inflation continues to rise 0.4-0.5% MoM for the next six months, then inflation will be 6% in the US, 7% in the UK and 6% in Europe,” a state of affairs he not-so-gently noted would “mak[e] total mincemeat” of inflation forecasts from the Fed, BoE and ECB.
I haven’t done the math myself, but I assume I don’t need to — the figure (above) suggests headline CPI in the euro-area would need to be 0.2% MoM in order for the ECB to be right.
As Bloomberg noted Monday, “not everyone is buying into the ECB tightening frenzy.” UBS’s European economist told BBG TV that inflation in Europe is likely to fall in the months ahead, albeit “gradually.” The ECB has effectively promised not to raise rates in 2022, and if you ask UBS, they’ll probably hold the line.
To (briefly) recapitulate, the ECB mapped out a path for bond-buying post-PEPP at its December meeting, citing “progress on the economic recovery and towards [the] medium-term inflation target.” The plan was billed as a taper — a roadmap to normalization. But it entails ramping up “regular” QE temporarily while pandemic QE is wound down.
It’s conceivable the ECB is so far down the rabbit hole that climbing out simply isn’t possible. Getting rates back into positive territory and bringing QE back to a €20 billion monthly pace is probably about as “normal” as it’s going to get. But that’s just my opinion.
In any case, BofA’s Hartnett also noted that we’re currently witnessing the “largest global tightening wave” in a decade. Over the past six months, there have been 49 rate hikes globally and just seven cuts (figure below).
That reflects, in part, emerging markets attempting to get out ahead of what’s expected to be an aggressive and prolonged tightening cycle in the developed world, with the Fed set to join starting in March.
In the same note, Hartnett served up the usual reminder. “Inflation always precedes recessions,” he said, adding that “the slower the Fed reacts on fears of upsetting Wall Street, the more inflation and recession risks grow.
‘“Inflation always precedes recessions,” he said, adding that “the slower the Fed reacts on fears of upsetting Wall Street, the more inflation and recession risks grow.“
I’m thinking a recession is already baked into the next 18 months somewhere along the way, even if it’s only a technical recession, and a job loss less recession, essentially a recession like we’ve never seen before in its make-up and effect. I would expect the majority of the effect to be in the value of financial assets of all sorts with China being the epicenter (which is also new).
I hadn’t thought about Larry Kudlow in 14 months, until I read the fourth paragraph of this piece.
I’ll be attempting a new, longer streak starting… now!