2017: A changing environment for central banks - Rabobank

2017 may have been extraordinary in terms of the political influences on G10 FX markets, but central banks have stolen a fair share of market attention, according to Jane Foley, Senior FX Strategist at Rabobank. 

Key Quotes

“In total the Fed hiked rates 3 times in 2017 bringing the total to 5 policy moves since the end of 2015.  Other central banks in the G10 have been warming up this year in preparation of a period of less policy accommodation.  The pace of moves, or in some cases perhaps a lack of policy action, will be a dominating theme for G10 FX markets into 2018 and beyond.”  

“In the past few years it has become increasingly apparent that tightening labour markets have been failing to generate much inflationary pressure.  Due to the fact that the US economic recovery is relatively firmly established, the apparent breakdown of the Phillips Curve has garnered most attention in the US. The result is that the pace of policy tightening from the Fed has been far slower than in previous economic cycles.  This has been a factor that has wrong footed USD bulls in recent years.  That said, Japan arguably offers a more extreme example of the breakdown between the expected links between tight labour market conditions and inflation, while Australia and the UK are also experiencing this phenomena.”  

“Last month Fed Chair Yellen stated that the sluggish nature of US inflation this year was mysterious.  However, the weakness of wage inflation and the tendency for workers to be paid a diminishing slice of national income would appear to offer a part explanation for the subdued nature of CPI inflation.  In several countries the owners of the capital rather the workers are benefitting from an increasing share of the payback bestowed by productivity gains.”

“Since workers are the larger consumer group, the weakness of wage growth has consequences for overall demand and therefore for demand pull inflation.  Given that this phenomena can be observed in several G10 countries, it would appear to be the consequence of structural factors such as technological changes, the creation of a plethora of low paid jobs and lower trade union membership.  Some central bankers appears to be more concerned than others.  The fact that two FOMC members, Evans and Kashkari, dissented against this month’s well telegraphed decision to raise rates by 25 bps adds weight to our expectation that in the face of stubbornly low CPI inflation the Fed will only hike rates twice next year.”

“Our forecast is also strengthened by the softer than expected reading for US November CPI at 0.1% m/m.  The downward move in t-note yields in response to this data release, sapped the strength of the USD, giving the EUR an opening to push higher. That said, the move was short-lived.  If the main effect of the December FOMC press conference was to rein in expectations about the pace of policy tightening, the impact of the ECB policy meeting was similar.”