Late last month Turkey’s central bank delivered the 1,000th global interest rate cut since the collapse of Lehman Brothers. The predictably contrarian Turkish move is likely to cap a remarkable era of easy monetary policy, with “quantitative tightening” the new market zeitgeist.
Bank of America, which tallied all those post-crisis rate cuts, estimates that central banks have also bought $23tn of financial securities over the same period through an array of quantitative easing programmes. But its analysts now expect this “liquidity supernova” to finally fizzle out next year.
The Bank of Canada last week became one of the first central banks to break ranks, unexpectedly ending its bond purchases entirely and signalling that it will lift interest rates sooner than expected in 2022. The Reserve Bank of Australia has also turned surprisingly hawkish. But the big event will come later this week, when the US Federal Reserve is expected to start trimming its $120bn-a-month bond-buying. Could we truly be seeing the beginning of a new era for monetary policy?
Many analysts and investors think so. “Central bank policies are on a one-way train toward less accommodation,” argues Matthew Hornbach, Morgan Stanley’s global head of macro strategy. In a classic case of investment analyst verbal contortion, he has dubbed the looming market regime TNT — which stands for “taper, inflation, tighten”.
In other words, many major central banks are expected to taper, eventually end and ultimately unwind their bond purchases. Some think that accelerating inflation will force them to further tighten monetary policy and actually raise interest rates aggressively. Given how frothy financial markets are, the result could well be as explosive as Hornbach’s acronym indicates.
Some investors seem positively gleeful about the prospect, sensing epic trading opportunities. Inflation is “probably the single biggest threat to certainly financial markets and I think to society just in general”, hedge fund giant Paul Tudor Jones recently told CNBC. Twitter’s Jack Dorsey apparently found this too understated, and predicts that global “hyperinflation” is coming.
The bond market has taken note. After long being relatively sanguine about the dangers of faster inflation and more hawkish central banks, shorter-term government debt — the slice of the fixed income market most sensitive to interest rate changes — has sold off hard this autumn.
For sure, the direction of travel is clear. Inflation has indeed jumped higher and stayed elevated for longer than many central bankers predicted earlier this year. There is a risk that disorderly supply chains ripple through the global economy and cause inflation to run uncomfortably hot.
Most of all, the economic recovery from the coronavirus has been wonderfully strong. So it makes sense that central banks start scaling back emergency stimulus, and in some cases even start raising interest rates cautiously.
However, the current narrative feels a little too elegant. As if it has sprung fully formed from the fevered dreams of long-frustrated hedge fund managers or crypto utopians that have been wrongly predicting runaway inflation for years. Fears of serious, durable inflation, aggressive central bank action and subsequent financial market chaos are still wildly premature.
The violence of the recent short-term bond sell-off looks like it has been exacerbated by hedge funds being forced to liquidate trades. Notably, longer-term government bonds remain sedate. That reflects the view that inflation is accelerating but will still ultimately settle back down to the low levels seen over the past few decades.
After all, the forces that have battered down inflation since the 1980s — such as globalisation, technology, demographics, debt burdens and the weakening bargaining power of labour — are unlikely to reverse.
The bond market’s overall message is that the real danger is central banks losing their nerve and overreacting to something that they in practice have little control over. Raising rates will not fix congested ports, logistical bottlenecks, selective labour shortages or under-investment in energy infrastructure. But doing so prematurely could hamstring the economic recovery.
A few notable exceptions aside, such a mistake still seems unlikely. The three central banks that actually matter are the Fed, the European Central Bank and the Bank of Japan. None is likely to slam on the brakes soon, even if inflation does not immediately begin to subside. A new monetary regime is starting, but the reality is that it will probably look uncannily much like the last one.