“The central-banking playbook of the 2010s is failing,” says The Economist. Policymaking that was designed for an era of low global inflation is leaving central banks “slow on their feet” and behind the curve on inflation. Now they are racing to catch up. Last week, America’s Federal Reserve raised interest rates by 0.75%, the biggest hike since 1994. The Fed wants investors to believe it will act decisively to tame inflation, “yet it is loath to admit that doing so will probably require a recession”.
The historical record is not encouraging, agrees Jon Sindreu in The Wall Street Journal. “‘Soft landings’ are easier to find in the legendarium of central banks than in historical reality.” Of the 12 times since the 1950s that the Fed has embarked on a major tightening cycle, “nine ended with a recession… The BOE [Bank of England] has a better record, but roughly half of its rate-increase campaigns since the 1950s still ended with a UK recession”. For tighter monetary policy to have any effect on inflation it needs to mean pricier credit or lower asset prices. “That this can happen without affecting anyone’s ‘real’ material conditions is wishful textbook thinking.”
The sell-off widens
Asset prices are certainly slumping. Both the S&P 500 and the tech-heavy Nasdaq index have lost ground in ten of the past 11 weeks. The S&P 500 suffered its worst week since March 2020 last week, plunging 5.8%, and is down 22% so far this year in total return terms. That puts it on track for its worst first-half performance since 1932, says Jim Reid of Deutsche Bank. Bonds, a traditional safe-haven, have offered no respite either, since ten-year Treasuries are currently on track for their worst first half since 1788.
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Talk of a coming recession has also started to weigh on commodity markets, says Randall Forsyth in Barron’s. Nearby crude-oil futures ended the week at $109.56 a barrel, down 9.21%. Meanwhile, copper, the most “economically sensitive commodity”, has fallen by 18.5% since it reached a high in March.
The Bank of England bottles it
While the Fed resorts to “shock and awe” tactics to tame inflation, the Bank of England is “playing a game of slowly, slowly”, says Laith Khalaf of AJ Bell. The day after the Fed’s three-quarter point interest-rate rise, the Bank’s monetary policy committee (MPC) followed with a far more cautious 0.25 percentage-point rise of its own, taking UK interest rates to 1.25%. Such “an incremental strategy allows the rate-setting committee to observe more data as it comes in, and fine-tune its approach as circumstances dictate”.
The modest increase was typical of the “head-in-the-sand behaviour that has cost the Bank of England so much of its inflation-fighting credibility”, says Liam Halligan in The Daily Telegraph. Tweaking rates is hardly an adequate response when annual inflation is running at more than four times the 2% target and the Bank itself expects CPI inflation to peak at 11% this autumn. “The MPC needs to demonstrate that it… can beat inflation – before its independence is taken away.”
Japan bucks the tightening trend
The Bank of Japan (BOJ) has its printer “on overdrive”, says George Saravelos of Deutsche Bank. While other global central banks tighten policy, Japan is resisting pressure from markets to follow suit. At the current pace, it’s on course to buy ¥10trn in government bonds this month. Relative to GDP, that equates to the US Fed buying $300bn of bonds per month; in reality the Fed bought $120bn per month last year. Is the BOJ so determined to generate inflation that it is “willing to absorb the entirety of the Japanese government bond stock?”
The BOJ’s decision to buck the global tightening trend has sent the yen down 16% against the dollar so far in 2022, to its lowest level in 24 years. Investors are sceptical about Japan’s ability to keep money easy for much longer, says Reshma Kapadia in Barron’s. Japan’s “decades long battle with deflation” explains the BOJ’s reluctance to recognise the new danger. Inflation remains low for now – at 2.5% – but a weak yen makes imports expensive, which is a severe concern for a major energy and food importer. Meanwhile, the ageing population relies on fixed income. “Inflation is kryptonite to those assets.”
Traders who think the BOJ will be forced to tighten policy have been shorting ten-year Japanese government bonds (JGBs), sending yields towards the 0.25% cap that the bank targets. Betting against the BOJ is a dangerous play, so dangerous in fact that it is “known in bond markets as the widowmaker trade”, say Anna Hirtenstein and Julie Steinberg in The Wall Street Journal. Yet with inflation stirring, some believe that this time is different. “I don’t really see how they can hold this. We are positioned for them ultimately having to move to a different policy,” says John Roe of Legal & General. “A surprise BOJ move could trigger substantial turbulence in global markets
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