Just as the markets had convinced themselves they were in for an uneventful carryharvesting summer, something started to change at the end of the month, with central bank communication seemingly dominating economic data with respect to their impact on market moves. Whilst the theme of disinflation continued to play out in the economic numbers, a growing concern around new central bank hawkishness dominated the moves in global bond yields. We had a negative month of performance as our long duration positions suffered with the rise in bond yields triggered by these comments.
March, June and December are generally the most significant meetings on the central bank calendar. They are typically accompanied by either a press conference where a central banker will be able to flesh out their thoughts on the future of monetary policy, or answer more specific questions from the press. These meetings also provide an opportunity for central banks to publish new forecasts of growth and inflation, although their historical accuracy of such economic forecasting has left much to be desired. June is usually especially important as it’s just before the (northern hemisphere) summer when central bankers and politicians break for an extended holiday, so it is the last chance to signal intent before the liquidity lull.
This month, ECB President Mario Draghi was the major market mover who unwittingly caused a mini-VaR shock, doubling German Bund yields in less than a week. European markets led the move higher in yields, underperforming most other regions, taking the currency with them as the Euro climbed c.3% against the Dollar. The US yield curve steepened more dramatically than it did after the US election. Australian interest rates subsequently underperformed heavily as they do every time you see moves like this. Even commodities seemed to be basing and performed well into month-end, no longer dominated by China growth concerns that have troubled the market for most of this year
The loquaciousness of central bankers
The reliance on central bank communication, because we are in a world of zero or negative rates, has both its positives and its drawbacks, but we feel that generally central banks communicate way too much. Communication, as one of the touted tenets of modern monetary policy, is a much more bizarre component than forecasts, and a far more complicated part. This month whether this was via press conferences or speeches, they were plain confusing and open to a myriad of different interpretations, but to our reading there was a definite hawkish turn evident.
Draghi’s speech, albeit similar to his remarks during the ECB meeting press conference earlier in the month, had changed enough of his views to be taken as hawkish, and lit the fuse. Over the month there were also a number of other central bankers (US, UK, Canada, Norway, Korea, etc.) who had taken a decidedly hawkish shift. This sparked rumours of a ‘pact’ between central bankers formed at a gathering in Sintra, Portugal. Their purported aim was to put forward a less accommodative plan for monetary policy. This is crucial because globally inflation numbers have disappointed recently and the markets have been moving towards expecting more, not less, monetary accommodation. So what exactly did central banks say to alter these expectations?
Looking through the minutiae of central bank verbiage, we can draw some broader trends from recent communications. Firstly, nearly every central bank either removed the prospect of further rate cuts in the future, talked about rate hikes in the future being appropriate or actually hiked rates. This undeniably is an across-the-board hawkish move by all of these central banks, and it is reflective of the better underlying growth picture in the global economy. Secondly, all central banks that produced a forecast for inflation as part of the meeting revised future inflation down (with one key exception, the Bank of England), while growth was kept more or less the same. Since most central banks are inflation targeting, in one sense or another, this was a dovish move. These two trends are not entirely inconsistent, and may in fact represent a fairly balanced message from the central bankers. The removal of any future easing bias can be justified by the current growth picture (when viewed in the context of post GFC growth), while inflation disappointments mean more uncertainty about the future and hence a need to treat the economy with caution.
Yet we know that the market is biased to be more optimistic on growth, to want higher yields, and if the economic environment is ‘OK’, then to interpret central bank communication to be more hawkish. We feel there is a degree of this in the interpretation over the month but it is also clear via comments from both the Fed and the ECB that they are now prepared to ignore the apparently ‘temporary’ period of lower inflation (which has been reflected in their forecasts).
Whilst stronger growth with temporarily low inflation could be one reason why policy may need to shift tighter in central bankers’ minds, a far scarier reason might be driven by concerns over financial stability. The latter reasoning supports a case for hiking as much as equity markets will allow, and if symptomatic of a systemic shift in policy outlook, will bring volatility back to the markets, driven by a likely unwind of the financial largesse we have seen over the last few years. In the former case, we question just how ‘temporary’ is the current low inflation situation, and whether a hawkish stance can be maintained if inflation heads down further. The story here starts with some really disappointing inflation prints in the US.
Full report here: (VIEW LINK)