Dramatically, Federal Reserve Chair Jerome Powell is a dove no more. But his hawkish pivot has the bond market shrugging its shoulders and carrying on, regardless. There was a modest shift higher in the front end with expectations for the first interest rate hike now coming a bit earlier — but the rest of the yield curve simply ain't buying it. The U.S. 30-year yield fell to the lowest level since January.
This should properly spook the market — akin to the sharp selloff earlier in the autumn when the Bank of England’s sudden volte face caused a major repricing of interest rate expectations globally, not just in the U.K. But once bitten twice shy. Now jaundiced bond traders are viewing pretty much anything tumbling from central bankers' mouths as suspect.
Talk is cheap but real action from the major central banks — leaving aside the growing list scrambling to defend their currencies against the omnipotent dollar and rampant inflation — is still viewed as unlikely. A flattening yield curve portends slower growth. While we are a long way off from an inverted curve and any thoughts of recession, it does seem that the economic outlook for 2022 and beyond has dimmed and that is outweighing inflationary fears.
Yet it's hard to think how more hawkish Powell could have been with the verdict still out on the seriousness of the omicron variant. Using the epithet “transitory” to describe anything other than travel is no longer welcome in central banking circles. And even though the Fed QE tapering program is barely a month old, it is the central bank’s urgent desire to finish it all super-quickly. If there is no longer monetary stimulus being poured in, then it hastens the agenda for withdrawing it. That means raising the official Fed funds rate. That had been a 2022 item of business. The question now is how soon.
We've seen this movie before and we know the ending: More stimulus will be along soon enough. That’s because supposedly independent central banks and their wastrel governments are hooked on monetary pump-priming as a cure-all. Yanking rates higher is more likely to crash the economy first than magically stop inflation in its tracks. And so the grim prospect of a policy error remains at the top of investor worry lists. Omicron only further complicates an already muddled picture. If in doubt — as they say in Yorkshire — do nowt.
Catherine Mann, an external member of the Bank of England’s Monetary Policy Committee made clear Tuesday that she thought it too early to talk about the scale or timing of a rate hike for the U.K. That totally undercuts BOE Governor Andrew Bailey’s hawkish mantra and illustrates the abundant policy confusion. Understandably, sterling money markets now put it as a coin toss whether the BOE delivers on a rate hike at its Dec. 16 meeting.
Meanwhile, a German bund 10-year yield of -0.3% tells you all what the market expects the ECB to do: Keep buying lots of European government bonds and keeping interest rates negative.
We can’t handle the old-fashioned truth of using higher interest rates to tamp down inflation. We’re too far down the road of unsustainable government debt loads to contemplate anything as gauche as settling our bills. The sugar rush of fiscal stimulus is wearing off and — unlike monetary QE — politicians have to justify and vote for budget deficits and spending plans. Nothing can match the flood of money that swamped the global economy in 2020. Even as multi-trillion spending bills struggle to make it through the U.S. Congress, the well is expected to run dry after midterm elections in November.
The U.K. is already headed down the fiscal tightening route. It should be a interesting experiment. The EU has a 800 billion euros ($900 billion) recovery pot to burn through, but that is modest by U.S. standards, and has to be shared by 19 countries and 450 million people.
At some point, comes the hangover. And the only ready headache pill is more QE and super-low interest rates. The bond market is looking for more of the same medicine being doled out when the next downturn or stagflation comes along. These central bank horses scare easy.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.