Think the Fed’s job is tough? At least the US Federal Reserve can focus on fighting inflation, In Japan and Europe, central banks are grappling with not just price increases, but markets as well. This is leading to some very strange, even contradictory policies.
The trouble with the three central banks means investors must be prepared for the low-probability, high-risk risks that lead to extreme price movements. When central banks unexpectedly go into complete reverse, beware. Let’s go through the risks.
fed It failed to contain inflation because it spent too long looking to the past as part of its policy of being “data driven” and therefore kept rates too low for too long. By sticking to the data-driven mantra, it runs the risk of repeating the mistake in the opposite direction, increasing the chances that it will cause the next recession and have to 180. Since the market Price has barely started in the downturn And hence the fall in earnings, which will lead to losses.
On Wednesday, Fed Chairman Jerome Powell went even further, saying he would not “declare victory” on inflation until inflation had fallen for months. Since inflation typically peaks at the beginning of a recession or after it begins, it makes it difficult for the Fed to stop tightening.
Mr. Powell talked about Finding out empirically at what level of interest rates slows the economy significantly. My read of it is that the Fed has committed to continue hiking until something breaks out.
european central bank There is a familiar problem: politics. on Wednesday ECB held an emergency meeting To solve the problem of Italy and to a lesser extent Greece. The ECB is looking to ease rising heat in Italian bonds, where the 10-year yield jumped 2.48 percentage points higher than Germany’s before falling following ECB action.
Unlike a decade ago, when then-ECB chief and now Italian Prime Minister Mario Draghi pledged to “do whatever it takes”, the central bank’s action has come before the fire, which is commendable. But the interim measure to redirect some of the matured bonds bought as pandemic stimulus to beleaguered eurozone countries is relatively small.
The ECB promised to expedite work on a new “anti-fragmentation tool” as a long-term solution, but here it plays out in politics. The wealthy North has always sought terms in exchange for throwing money into troubled countries, to ensure that they do not use low bond yields as an excuse for yet more volatile lending. But until flames are engulfing the economy, troubled countries do not want the embarrassment and political mayhem of accepting oversight from the International Monetary Fund or the rest of Europe.
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It would be difficult for the ECB to buy bonds in Italy to keep yields low while at the same time raising interest rates elsewhere. At least it has to impose stricter policy on other countries than other countries. At its worst, it would be at the existential risk that Italy could one day default, as Greece did, for the ECB to crush its own finances. Both are politically toxic.
At the moment Europe’s inflation problem is different from America’s, because wages are not running wild. But if Europe follows the US, rates could rise so much that slow-moving Italy would struggle to pay interest on its government debt, which amounts to 150% of GDP, regardless of the ECB. No matter how narrow the spread. German bond.
Even a small risk of Italy falling into trouble justifies dumping its bonds, as higher yields become self-fulfilling. When higher returns increase the risk of default, they make bonds less attractive, not more attractive. Left on their own, the market will continue to push them into an endless spiral.
bank of japan Is also fighting the markets, although he has a better chance of winning than the ECB. Investors are betting that
The bond would be forced to raise its limit on yields, which is known as yield-curve control. In theory the BoJ can buy an unlimited amount of bonds, so it can maintain the cap if it so desires. But if investors believe that inflation justifies the higher returns, the BoJ will have to buy ever-increasing amounts of bonds, as investors will not want them, as the late economist said. Milton Friedman told in 1968.
Japan has the best case scenario of any major developed country easy monetary policy, While inflation is above 2% for the first time since 2015, it is almost all due to higher global energy and food prices, and little pressure for higher wages. Excluding fresh food and energy, and annual inflation was 0.8% in April, there is hardly any reason to panic.
Still, inflation is rising, and increasing the risk that the BoJ will have to give in, leading to a move in bond yields – the kind of change that could crack markets globally. When the Swiss Central Bank dropped its currency cap in 2015, many hedge funds bet it would stick to their guns, and some were forced to close. Japan is several times more important than Switzerland, which rocked the currency markets last week with an unexpectedly sharp rise in currency markets. a huge increase in the franc,
This gloom is avoidable—central banks are smart enough. But the potential for major mistakes is greater than they should be, which means that the risk of extreme events in the markets is increasing. This calls for caution on the part of investors.
write to james mackintosh James.mackintosh@wsj.com
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