International organizations such as the United Nations have criticized aggressive monetary policy by central banks seeking to combat inflation. These organizations fear that the current level of synchronized central bank tightening can produce financial blows that may contribute to significantly lower economic growth prospects globally. Higher developed-world interest rates weaken emerging market currencies and make it more expensive for those nations to service debt and buy commodities denominated in dollars, weakening economic performance. Additionally, higher rates in the developed world lead to money fleeing emerging markets as investors chase higher “risk-free” returns in U.S. Treasuries or in other safe assets in developed nations, hampering economic growth as well. While central banks consider global ramifications when conducting monetary policy, to the disappointment of the United Nations, they tend to largely prioritize their own jurisdictions.
However, in the past few weeks, some central banks have taken dovish actions, including the following:
- Earlier in the week, the Reserve Bank of Australia implemented a surprise 25 basis points interest rate hike, less than the 50 basis points expected by the market.
- Last month, the Bank of England responded to trouble in the gilt market by temporarily buying long-term bonds, a dovish tilt from a central bank that was primarily determined in curbing inflation.
- In Japan, the BOJ has maintained its dovish position by intervening in currency markets, buying bonds and keeping interest rates low.
Certain international organizations want more of this because looser policy in developed markets, while inflationary, would reduce economic and financial stability risks in emerging markets. In the European Union, on the other hand, President Lagarde of the ECB argues that the bank should stop stimulating the economy by slowing the reinvestment of bond coupons and by increasing interest rates further. The International Monetary Fund has been supportive of decisive central bank action, with managing director Georgieva seeing global inflation as the primary risk.
Here in the States, the overall rhetoric has been hawkish with examples including the following:
- Fed Bank of Richmond President Thomas Barkin noted that while the stronger dollar has the potential to weaken economic conditions globally, the Fed is focused on the U.S. economy.
- Vice Chair Lael Brainard warned against prematurely loosening policy because it can reignite a renewed inflationary surge, such as in the 1970s when Fed Chair Arthur Burns loosened policy too early.
- Fed Bank of Atlanta President Raphael Bostic noted that changes in supply chains and global commerce post-pandemic may reduce efficiencies and add to inflationary pressures. He believes businesses are more willing than in the last 30 or 40 years to tradeoff efficiencies and lower operating costs for reliable and safe production, an inflationary development.
- Fed Bank of Cleveland President Loretta Mester thinks the U.S. won’t have financial stability problems, current rates are not in restrictive territory and that a U.S. recession won’t stop the central bank from raising rates.
- Presidents Daly, Kashkari, Williams and Bullard of San Francisco, Minnesota, New York and St. Louis, respectively, believe inflation is the primary problem the central bank is fighting. They all support tighter policy.
- Finally, Chair Powell has turned from lenient and patient in 2021 to agitated and unwavering in 2022 as his comments have shifted to price stability above all. A similar message was heard in the 1980s from the late Fed Chair Paul Volcker, who Chair Powell admires for tackling a challenging problem, inflation, with unpopular tools: higher rates and recession.
Despite U.S. central bankers’ hawkish statements, markets were cheering the possibility of banks in other countries embracing looser policies with the S&P 500 Index up roughly 3% yesterday, while most of the yields across the duration curve were down notably from recent highs. The 10-year yield was down to 3.62% while the 2-year yield was down to 4.1%, much lower than the 3.99% and 4.36% levels seen on September 27, just over a week ago. Commodities were up broadly, celebrating the hopes of increasingly dovish shifts, with West Texas Intermediate Crude oil rallying 4% and nearly reaching $87. Hold on a sec, if commodities are going up, isn’t that terrible news on the inflation front? Of course it is, and that’s the problem with loosening policy at this juncture: it boosts demand alongside price pressures. While some entities are currently prioritizing economic growth and financial stability over inflation, others believe that inflation should be of utmost concern. Ultimately, the side central banks tilt to in aggregate holds the key to the direction of equity and bond markets.
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