Central banks exercise the pandemic option and keep markets waiting


Global markets have been anticipating the end, or at least the beginning of the end, of central bank intervention since January.  Bankers, led by the US Fed, have been very reluctant to end their accommodation. The pandemic mutates, the bankers wait and markets spin their wheels.  Join FXStreet senior analysts Valeria Bednarik, Eren Sengezer and Joseph Trevisani for a in-depth discussion of the variables behind central bank policies.

Valeria Bednarik: So, we had announcements from the RBA, the BOC and the ECB this week. The three central banks fell short of the market's expectations, by maintaining the status quo, despite facing three different realities. What's up? Are we too confident about the end of the pandemic and the economic comeback, different to policymakers? I can get Australia being conservative, but can't justify the Canadian or the European stance.

Joseph Trevisani: The differences are interesting.  Australia has chosen a draconian approach to Delta...which will damage the economy.

Valeria Bednarik: They don't realize their initial strategy vs the pandemic is not enough with Delta.

Joseph Trevisani: Canada and Europe have largely kept their economies open...as has the US. Agreed but the choice this time has not been to lockdown but to treat rather than prevent.

Valeria Bednarik: And still, with the economy moving towards the right direction, central bankers are quite conservative.

Joseph Trevisani: It is essentially the Swedish choice from the beginning.  Still the impact is unavoidable.  US GDP now forecast at 3.7% from the Atlanta Fed in the third quarter...barely half of the first two quarters.

Valeria Bednarik: Would that temper inflation?

Joseph Trevisani: I don’t think so.  Rate policy has a long lead time for inflation impact.   I think the banks are worried about inflation expectations, on those a policy change could have effect.

Eren Sengezer: I don't think so. At least not in the US. The Fed's Beige Book showed that inflation was steady at an elevated pace in all districts and producers anticipated significant hikes in selling prices. 

Valeria Bednarik: Yeah, good point there.

Eren Sengezer: Supply disruptions and labor shortages are still major problems.

Valeria Bednarik: Lagarde also referred to bottlenecks. "If supply bottlenecks last longer and feed through into higher than anticipated wage rises, price pressures could be more persistent." That's what she said.

Joseph Trevisani: The economic recovery has not evolved as the banks or economists expected. In defense, it was and is a novel situation, (no pun intended).  I think it has been compounded by economic changes which were already underway--primarily home work--but have now exploded. I think we are seeing the wage pressures. The contrast between the JOLTS numbers and the initial jobless claims is striking in the US.  Jobs are going begging and layoffs are falling, yet unemployment, at least by official measures remains high. My guess is that more people are working than is being captured by the government figures. But for central banks, How to assess this discrepancy?

Valeria Bednarik: There are no wages pressures in Australia, nor in the EU...

Joseph Trevisani: Yes I was speaking of the US.

Eren Sengezer: I think the mismatch between the labor demand and supply continues to blur the central bankers' vision. The structural change in the labor market is likely to take some time.

Joseph Trevisani: Rate policy is better attuned to inflation, even at a lag, than to the labor market.

Eren Sengezer: Yes, I agree. That's why I feel like the Fed will opt out to reduce asset purchases before the end of the year despite the disappointing August Nonfarm Payrolls.

Joseph Trevisani: I think they will also but not in September.  August NFP squelched that.

Eren Sengezer: Yes, December seems likely. They will look to anchor inflation expectations while letting the labor market play out.

Joseph Trevisani: Any tapering can be very flexible, in amount and timing.

Eren Sengezer: Exactly.

Joseph Trevisani: The Fed has three more meeting.

Eren Sengezer: What do you make of Lagarde's note that their decision to say "favorable financing conditions can be maintained with a moderately lower pace of PEPP purchases" in the statement was an adjustment rather than tapering?

Joseph Trevisani: Semantics but understandable.  None of the central banks want credit markets to raise rates so they are pretending that reducing their bond purchases will not impact rates.

Eren Sengezer: I think they have the option to increase APP purchases when PEPP winds down and essentially keep the same amount of accommodation. So, that would make today's announcement a technical adjustment.

Joseph Trevisani: Yes but once markets understand the accommodation is ending the normal response is to front-run the move.  That is what all the banks are trying to forestall.

Eren Sengezer: In that sense, I feel like the ECB has more flexibility compared to the Fed.

Joseph Trevisani: And lower expectations.

Eren Sengezer: Do you think that will weigh on EUR/USD in the last quarter? Or is it already priced in?

Joseph Trevisani: I dont think changes in bank policy, if any, are priced. The first quarter saw the US Treasury market price a policy change, and it dissipated.

Valeria Bednarik: Agree that central bankers are trying to avoid wild reactions to tightening. Yet at the same time, speculative interest is eager for something "fresh" and tapering has the highest chances at this point. We need clear imbalances between policymakers to see a trend. Meanwhile, their moderate speeches keep us waiting.

Joseph Trevisani: Exactly, so far the bankers have had it both ways, tentative steps toward ending their pandemic policies, but without exciting a wholesale rate move.

Eren Sengezer: They also want markets to know that they will not hesitate to act if they see warning signs. After all, it seems as if the virus is here to stay.

Joseph Trevisani: The pandemic has been the key restraint.

Valeria Bednarik: And we are not yet adapted to live with it.

Joseph Trevisani: I think the virus is here to stay.  How could it be otherwise?  But the economic situation is uncertain enough to restrain markets, knowing that the bankers will act if things become worse.

Valeria Bednarik: What's your take on who will tighten first? Does the Fed tops the list?

Joseph Trevisani: For the markets it is still a waiting game, and the initiative is with the banks. I think the Fed's taper matters the most, as it will liberate the others.  The difficulty is whether the US Treasury market follows to the logical conclusion?

Valeria Bednarik: Agree with that. The Fed should be the first to move. And whatever happens to the US Treasury market will be short-lived. A few months ago we were watching the 10-y note behavior around 1.70%. Now, we lowered the bar to 1.30%...

Joseph Trevisani: Exactly.

Eren Sengezer: I also think that the Fed needs to act first and open the door for other central banks to do the same. To me, this means we could see additional USD strength unless the economic recovery loses momentum.

Valeria Bednarik: Ok, guess we will have to keep waiting. Patient is THE pandemic lesson...

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