By Elwin de Groot, head of macro strategy at Rabobank
Is it the Super Bowl? No! Is it Super Grover? No! It’s Central Bank Super Thursday! And the big question for today is whether Fed Chair Powell did -with his hawkish shift yesterday- some of the heavy lifting for other central banks that are either on the fence (such as the BoE) or for those that have basically stuck with the “inflation is transitory” narrative, which of course refers to the ECB.
But let’s first look at what the FOMC decided and how markets reacted to its shift of stance. After all, this may give indications of what markets are willing to bear or perhaps would even be looking for today and in the coming months.
To start with, the Fed, as signaled earlier to the market, deleted the “transitory” word from its statement, pointing instead to a more simple qualification of “elevated levels of inflation”. It also decided to double the pace of tapering its asset purchase programme to USD 30bn/month, with an intended end to the programme by early March. This gives the Committee the option to hike as soon as March 16. Indeed, an upward shift in the dot plot now implies three rate hikes in 2022 – making it more hawkish than expected. This shift, according to Powell was motivated by rising wages (specifically the high employment cost index), and the strong labour market report and CPI following the last FOMC meeting. With this change of tone, the Fed clearly wants to show that it is now taking inflation seriously, creating an option to hike in the spring of 2022.
Powell also acknowledged that the economy is much stronger than it was prior to the previous hiking cycle. However, as our Fed watcher Philip Marey notes, it is not a pre-commitment. As the FOMC has said repeatedly, the end of tapering does not automatically mean the start of hiking. And it has a long history of not delivering on its projected rate hikes. How much of this hawkish posturing will remain if the economic recovery faces another setback? Or if markets get nervous?
Perhaps this also explains why the market’s reaction to this hawkish shift was remarkably muted. Of course, it wasn’t a complete surprise following the feather ruffling since October. At the end of day, Treasury yields were hardly changed (we wouldn’t dare call a 0.6bp rise in 2y and 1.5bp rise in 10y yields a steepening move!). And equities obviously were higher (S&P 500 up 1.6%), as Bloomberg notes that investors are happy with the Fed taking inflation more seriously. Seriously?
In any case, Omicron didn’t feature prominently in the FOMC’s deliberations. But this may be different with some of the other central banks. Alongside many others, the Bank of England’s Monetary Policy Committee will publish its decision on interest rates today. A first rate increase to 0.25% from 0.10% long looked like a done deal. After all, when the MPC surprised the markets in November by keeping its policy unchanged, it judged there was “value in waiting” for more information on how the labor market would absorb the end of the furlough scheme. We now know this went fairly well. All the while, inflation continues to surprise to the upside, reaching 5.1% y/y in November. That said, the extremely rapid spread of Omicron casts uncertainty over the short-term economic outlook. This may nudge the majority of the MPC to judge there is again “value in waiting”; this time to find out how the pandemic develops. In any case, money market traders seemed to have grasped Pill’s lesson and decided to hedge their bets: the implied probability of a rate increase is currently around 50%. We expect the MPC to keep rates unchanged once more, even as the BoE feels duty bound to show some willingness to prevent inflationary pressures from persisting. Please see here for our preview.
Staying briefly with Omicron, the warnings by some health experts in the UK and US are nothing short of alarming. For example, as the FT reports, Ali Mokdad, professor of global health at the University of Washington warned that the low vaccination rate in the US made it “[…] very exposed and in real danger.” But the UK is probably providing us with the most timely and acute warnings, with Johnson’s top medical advisor, Chris Whitty, talking about Omicron spreading at a “phenomenal pace” and of a substantial number of people being hospitalized being a “reasonably nailed on prospect”. Yesterday’s daily case number of nearly 78K was the highest on record.
With the current knowledge –and vaccination having proved very effective in keeping people out of hospitals– it is understandable that Omicron has quickly turned into a race between the virus and vaccination. But, in contrast to last year, this is taking place against a backdrop of relatively light lockdown measures and hence a light support regime for businesses. This fits with the idea that we have ‘learned to live and cope’ with the virus. But we should also bear in mind that learning doesn’t always mean we learn the right things. Governments took action as soon as Omicron was detected, under the assumption that its impact would be less than Delta. But previous strains were probably much longer among the public before the health impact could be assessed. Moreover with the huge speed of contagion, UK businesses warn that people might still voluntarily change their behavior in spite of light containment measures, which could prove a challenge for those businesses that now also receive a much lighter support package. In other words, complacency could lead to considerable economic damage if the initial assessment of Omicron (high contagiousness being offset by lower health impact) turns out to be false after all.
