Central banks face jumpy bond market with 10 days of policy decisions

The Marriner S Eccles Federal Reserve building in Washington, DC. Photo: Bloomberg
Central banks helped save the world economy from depression as the pandemic struck. Now they are dealing with the hard part: managing the recovery amid a difference of opinion with investors.

Optimism that Covid-19 vaccines and continued government stimulus offer an escape from the worst health crisis in a century has sent bond yields soaring and pushed bets on rising inflation in the U.S. to the highest in a decade.

That’s shifting the ground underneath monetary policy makers who promise to maintain rock bottom borrowing costs and cheap money well into the expansion. In the next two weeks, the Federal Reserve and European Central Bank as well as their counterparts in Japan, U.K, and Canada are all likely to reiterate those pledges, eager to secure a rebound in hiring and avoid the mistakes of the last crisis when some withdrew support too early.

The risk now seems skewed the other way. While policy makers welcome a modest rise in bond yields as a signal of confidence in the economic outlook, they worry an unchecked jump would undercut recoveries. They argue any resurgence in inflation will be based on a temporary correction from last year’s slide and that high unemployment will continue to restrain price pressures.

It’s a stark turnaround from a year ago, when the world powered down to fight the Covid-19 pandemic and central banks responded with what’s amounted to an unprecedented $9 trillion of monetary support.

“Central banks are facing a new challenge,” said Rob Carnell, chief economist for Asia Pacific at ING Bank NV. “How do they keep justifying easy policy as the recovery continues and the inflation figures pick up?”

Canada, ECB

The Bank of Canada is first up with a meeting on March 10 when policy makers are likely to indicate they plan to maintain plenty of stimulus well into any strong recovery. It’s a case that Governor Tiff Macklem laid out last month when he argued policy needs to help foster not only the immediate pickup but also facilitate virus-driven structural changes like digitalization.

ECB President Christine Lagarde convenes officials the next day when updated forecasts will highlight how the euro-area economy is lagging the U.S. because of slow vaccine rollouts and extended virus restrictions. That puts the bloc at risk should higher global yields spill over into borrowing costs for companies and households.

ECB policy makers have surprised investors by downplaying their concerns so far, saying their bond-buying program is flexible enough to address unwarranted tightening but failing to provide any evidence that they’re accelerating purchases. At the back of their minds though is likely to be the experience of 2011 when interest rates were raised twice to combat faster inflation despite a worsening financial crisis, only for the euro zone to slide into a double-dip recession.

Powell Pressure

At the Fed’s policy meeting on March 16-17, Chairman Jerome Powell will likely reaffirm his looser for longer stance. Powell repeatedly stressed during remarks on Thursday that the Fed was a long way from its goals and was not close to tightening policy. He also played down a likely rise in inflation this year and ducked questions on a possible response to the recent sharp rise in yields.

While the move had “caught’ his attention, he said Fed policy was currently appropriate, though it has tools to respond if there is a material change in the outlook.

Transcripts of the Fed’s meetings from 2015, when it last began a tightening cycle, suggested policy makers overestimated the potential for accelerating inflation and underestimated the room still left in the economy to generate jobs.

What Bloomberg Economics Says...

For the U.S., rising bond yields are largely a reflection of confidence in the strength of the recovery. For much of the rest of the world, the spillover of higher borrowing costs is arriving too soon. The Reserve Bank of Australia has already reacted with bigger bond buys. Others may also have to tweak their policy settings.

-- Tom Orlik, chief economist

Taper Talk

The Bank of England convenes on March 18. It has lined up a further 150 billion pounds ($208 billion) of asset purchases over 2021 with plans to taper weekly buying later in the year.

A hugely stimulative budget from Chancellor Rishi Sunak now has economists further discounting the prospect of negative interest rates and instead looking forward to a tightening of monetary policy.

The central bank has said that won’t happen until there is clear evidence that spare capacity is being eliminated and it’s closer to sustainably achieving its 2 per cent inflation target, but in February announced it was considering whether to alter previous guidance that it wouldn’t unwind its asset purchases until the bank rate reached 1.5 per cent. Governor Andrew Bailey has indicated he would favor reducing the institution’s balance sheet before hiking rates instead.

BOJ, PBOC

Then it’s the Bank of Japan’s turn on March 18-19, when officials are scheduled to unveil details of a policy review that will look at how it controls yields, negative rates and asset buying. Governor Haruhiko Kuroda has said the central bank is seeking to make its policy framework more effective by fine tuning it rather than overhauling it. He has also signaled there won’t be any changes to the movement range around the 10-year yield target.

While developed-world central banks will likely be unified in pledging ongoing stimulus, China’s officials are already signaling the opposite. Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission -- the top banking regulator -- said on March 2. he’s “very worried” about risks emerging from bubbles in global financial markets and the nation’s property sector, stoking expectations of policy tapering.

That was followed by the government setting a conservative growth target of above 6 per cent for the year, well below what economists forecast the nation will achieve, as Premier Li Keqiang on Friday opened the National People’s Congress in Beijing.

The tension between inflation and cheap money is already forcing some emerging market central banks to move. Ukraine unexpectedly raised interest rates to counter the highest inflation in more than a year. Brazil is forecast to start raising borrowing costs on March 17 having promised in August to keep its 2 per cent benchmark for the “foreseeable future.”




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