Strategy: A tale of three central-bank camps

In a week which saw risk sentiment improving again following set-backs ahead of hurricane Irma and the imposition of harsher sanctions against North Korea, we also saw the Bank of England (BoE) signal a hiking cycle to begin sooner than we and the market were looking for, and the Swiss National Bank (SNB) emphasising its commitment to accommodative policy. In our view, this served to confirm that central bankers are now divided into largely three camps.

In the ‘exit' camp we have the central banks looking to ‘normalise' policy after years of using unconventional measures. A prominent member of this camp is the Fed, which has in fact been in tightening mode since the tapering discussion began back in 2013. But, this week's BoE meeting also clearly cemented that the BoE is keen to start a hiking cycle. And then importantly, in our view, there is the ECB, which has somewhat started talking about ‘reflationary' (rather than deflationary) risks – a wording once again used by ECB chief economist Praet in a speech reiterating the hawkish tone from last week's meeting.

In the ‘no exit' camp, we have the central banks keen to avoid joining the ‘normalisation' discussions taking place elsewhere, not least as they worry this could bring about unwanted currency strength. The Bank of Japan (BoJ) has clearly placed itself in this camp following the introduction of yield curve control and will likely stay in easing mode for an extended period as price pressure remains weak. This week's SNB meeting also confirmed that the Swiss are ‘in it' (negative rates and a bloated balance sheet) for the long run as sustained price pressure is lacking still.

And then there is the group of those in-between, reluctant to side with either camp: arguably these would under ‘normal' circumstances be looking to make policy less accommodative but are reluctant to do so as they are uncertain whether underlying inflationary pressure is strong enough to withstand currency strength along the way. This group in our view includes notably the Riksbank and Norges Bank, with the latter struggling with recent low inflation prints and the former insisting the latest inflation uptick is temporary; also both are wary of potentially wobbly housing markets.

Next up for revealing its preferences regarding policy is the Fed with the FOMC meeting next week, see FOMC preview, 15 September 2017. We expect the Fed to stay on hold but announce it will begin shrinking its balance sheet in October. The latter is widely expected and should not have a major impact on neither Treasury yields nor USD. But we also expect the median FOMC ‘dots' to still signal one more hike this year and three hikes next year, which remain far from market expectations. This week saw a decent inflation print out of the US which, alongside slightly improved prospects of a corporate tax reform in the US, should keep the Fed on track for a December hike, in our view, even if it is an increasingly close call.

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