Central Bank Policies

20th May 2022

FOMC MINUTES (WED): The Federal Reserve's May policy announcement was in keeping with market expectations. It lifted the Federal Funds Rate target by a 50bps increment to 0.75-1.00%, while the statement continued to suggest the Committee anticipates that "ongoing" rate rises will be appropriate. At the post-meeting press conference, Chair Powell leaned back against calls that the Fed could lift rates in 75bps increments, stating that the Committee was not actively considering hikes of that magnitude, and arguing that 50bps moves at the next "couple" of meetings was likely to be appropriate. The Committee also announced a phased-in start to balance sheet normalization beginning in June (some were expecting the process to begin in May); the maximum monthly caps will start at USD 30bln and USD 17.5bln for Treasuries and MBS respectively, ramping up to USD 60bln and USD 35bln over three-months. Powell said the effects of balance sheet reduction were uncertain, but there are estimates that it could deliver the equivalent of a 25bps hike over the course of a year, perhaps biasing the neutral rate to the low-end of forecasts. The Fed alluded to the negative GDP print in Q1, saying that although overall economic activity edged down, household spending and business fixed investment remained strong. Chair Powell is also confident that the Fed can engineer a soft economic landing as it lifts rates in the face of a growth slowdown, though he constantly caveated the challenges the central bank would face in that endeavor. Powell was dismissive about the prospects of an outright recession, and he said that there was nothing in the economy that suggests it was close to a recession, though that was not to mean there will not be some slowing of growth. On the notion that the Fed could lift policy above estimates of the neutral rate - something economists say will begin to restrict economic activity from the current accommodative stance - Chair Powell repeated that the Committee would not hesitate to hike above that level (which the Committee sees between 2-3%), but said that this was not a decision to be made now, implying he was in the camp that favored raising rates to neutral and then assessing the magnitude to which further rate rises were needed. Since the meeting, financial markets have seen episodes of sharp risk-off amid concerns about global inflation and a slowing growth impulse. Some had expected Fed officials to dial down hawkishness in order to cushion the unwarranted tightening of financial conditions engineered by the sharp risk off, however, key officials have not gone down this route; hawks like Bullard appear to be in line with the consensus of 50bps rate rises at the June and July meetings, while doves like Evans do not appear to be wavering as risk assets slide, all suggesting that the central bank would stay its course in tightening policy for now. One of the key emerging debates seems to be focused on what the Fed will do when it gets rates to neutral: will it pause the hikes and assess the situation, or will it revert to shallower 25bps increments rate lifts. Chair Powell this week reiterated the case that the Fed would continue with hikes until inflation was back at target. Given the Fed's challenge in dealing with high inflation, this line from Powell is to be expected - backing away from it now risks undoing the initial work in lowering inflation expectations. However, analysts will be looking to the minutes for any hints on how the Fed could inject dovishness while staying the course regarding normalization; analysts have speculated that the Fed might be able to project some dovishness by alluding to a lower terminal rate in this cycle, pausing when rates get to neutral; it could even suggest that the need for a larger 75bps increment hike was lower.

RBNZ RATE DECISION (WED): RBNZ will decide on rates next week in which it is expected to continue its hiking cycle as most analysts anticipate a 50bps increase by the central bank and OIS fully price in a 25bps hike with around a 90% probability of a greater 50bps move. The RBNZ has hiked rates for the past 4 consecutive meetings and even surprised markets in April with a larger than expected increase of 50bps (exp. 25bps), while it stated at the past meeting that it will remain focused on ensuring current high consumer price inflation does not become embedded into longer-term inflation expectations and monetary tightening was brought forward, but noted it remains comfortable with the outlook on the OCR as outlined in the February MPS. This suggests the central bank's more aggressive move in April was just front loading and its view for the actual destination of rates remains unchanged in which it had previously forecast the OCR at 2.84% in June 2023 and at 3.35% in March 2025. Nonetheless, the RBNZ is likely to continue the front loading with Westpac expecting three more 50bps rate hikes, while ASB Bank and Kiwibank are also calling for a 50bps hike at the upcoming meeting with the argument for tighter policy supported by inflation data after New Zealand CPI for Q1 rose at its fastest pace in 32 years.

ECB MINUTES REVIEW: The account of the ECB's April meeting was always likely to be deemed as stale by the market given how far the narrative surrounding the Bank has evolved since with a July 1st conclusion for APP and July 21st deposit hike very much the consensus. In terms of the content of the minutes, concerns were voiced over the inflationary outlook whereby it was noted that "there were increasing signs that the current high inflation was becoming entrenched in expectations, with a number of indicators of longer-term inflation expectations at least starting to become unanchored from the ECB's inflation target". Accordingly, some members viewed it as important to act without undue delay in order to demonstrate the Governing Council's determination to achieve price stability in the medium term. In terms of specific policy actions, it was noted that if the upside risks to the inflation outlook were confirmed in the June Eurosystem staff macroeconomic projections, the Governing Council would face the question of whether continuing net purchases beyond June could still be seen as proportionate. From a rates perspective, some members viewed the higher-than-expected inflation figure in March and inflation expectations moving above the 2% target as requiring an adjustment of the monetary policy stance towards a neutral position sooner rather than later. As such, an increase in interest rates was touted as a possibility shortly after the conclusion of APP. In terms of the pace of hikes, it was recalled that the expected path of the nominal key ECB interest rates would approach a neutral level only at a very late stage of the policy normalization process. From a growth perspective, it was underlined that, overall, the incoming data suggested that the Ukraine war would slow the recovery but not derail it, unless a less likely "tail" scenario materialized.

13th May 2022

ECB MINUTES (THU): As expected, the ECB refrained from tweaking its monetary policy settings with rates left unchanged and the parameters of its bond-buying operations maintained. As such, the ECB stated it will lower purchases under APP to EUR 30bln from EUR 40bln in May and then to EUR 20bln in June before concluding in Q3. The initial market reaction to the statement was a dovish one with a lack of specificity on when in Q3 purchases will conclude, serving as a disappointment to some who had been hoping for greater clarity. At the accompanying press conference, introductory remarks from Lagarde stated that several factors point to low growth ahead, new pandemic measures in Asia are contributing to supply chain issues and inflation pressures have intensified across many sectors. On policy measures, Lagarde refrained from providing any firmer pointers on when in Q3 purchases under APP will conclude. However, since the meeting, consensus has coalesced around the view that asset purchases will be concluded on July 1st. Lagarde also reiterated her line from the previous press conference that the "some time" linkage between the end of APP and start of rate hikes could mean "weeks" or "several months". In the wake of the meeting, Reuters ECB sources suggested that policymakers saw a July hike as still possible, but they were unanimous in their support for April's decision. Meanwhile, Bloomberg sources suggested there was a growing consensus for a 25bp rate hike in Q3. Note, on May 11th, Lagarde placed particular emphasis on the "weeks" aspect of this guidance with other officials at the Bank endorsing a move on rates in July. Finally, during her remarks, Lagarde didn't add anything to the reports ahead of the meeting which suggested that the Bank was looking at crafting a crisis tool if bond yields were to jump.

SARB PREVIEW (THU): The South African Reserve Bank is likely to lift rates by a 50bps increment, taking its Repo Rate to 4.75%, as it looks to manage the impact of higher inflation and potential second round effects. Elize Kruger, an independent South African economist cited by Reuters, said "workers will demand higher wages to compensate for higher living costs, also adding to the production costs in the economy and in this process prices in most of the CPI basket will show increases," adding that "the SARB would be very uncomfortable if second round effects start to appear in a meaningful way." A 50bps increment move has not been made by the SARB in over six years, and some analysts still expect a smaller 25bps, but they are in the minority. According to a Reuters poll, since the last meeting, analysts have been hawkishly revising their expectations towards the larger move. The latest survey, however, sees the central bank moving back to 25bps hikes per quarter until rates are lifted to 6.00% in Q3 next year.

BANXICO REVIEW: Banxico voted by 4-1 to lift rates by 50bps to 7.00%, as market participants were expecting; one member (Espinosa) voted for a larger 75bps hike. The central bank also added language to its statement that suggested that it could consider more forceful measures to attain the inflation target due to growing complexities in the environment for inflation and expectations; it also noted that headline and core inflation expectations had risen 'significantly', firming its language from the prior meeting. Longer run inflation expectations were stable, but remained above target. The statement also noted that global economic conditions were worsening and uncertainty continues to prevail. The drivers of inflation are judged to be little changed: high core inflation, COVID-related inflation pressures, higher commodity prices, MXN depreciation. Pantheon Macroeconomics' analysts now expect the Banxico to raise rates by a further 50bps at its next three meetings, and then 25bps rate rises in the final two meetings of the year, though caveat that risks tilted to the upside. "The main interest rate is at its highest level since early 2020 and policymakers have left the door wide open to further tightening," Pantheon writes, "we expect further hikes over the coming meetings, but the pace is uncertain, mainly depending on global food prices, the Fed, and the MXN."