What the ECB and the Fed wouldn’t give to have the UK’s inflation eh? Core CPI came in at a joyful above-target 2.7%. The cost of raw materials went up to 7.6% in the year to August from last month’s reading of 6.2%. Just in case there was any doubt as to what was driving it (clue: the Great British Pound), here’s a chart showing the marked upswing since that Brexit vote came upon us:
So, it’s pretty simple for Mario and Janet. If you want to hit your inflation target, engender an unexpected vote on the future trading power of your nation. Janet’s lucky, she got an unexpected vote on her political leader, but it took the market a while to catch up to his prospects of reform and thus re-rate the currency accordingly. Oh, how those central bankers must laugh (here they are at Jackson Hole):
But then poor Janet, because despite the significant loosening in US financial conditions this year, there still isn’t much inflation. Maybe that will improve on Thursday, right? When we find out the latest US inflation data? Small fly in the ointment – the next couple of months inflation data is going to be very messed up by pesky natural disasters. The hurricanes, as dreadful as they are, will ultimately prove reflationary, what with the rebuild and supply shortages. But they’re also going to confuse the hell out of the data. Here’s what happened to inflation readings after Hurricane Katrina:
That means it’s going to be very hard to tell what the underlying inflation rate is for the economy, absent these temporary shocks. Markets have to try to price the future regardless, and they’re doing a jolly good show of it too. Here’s the latest outlook for what’s priced into interest rates:
Not a lot, basically. The most excitement over the next 12 months lies in Canada, where a full 50bps of hikes is priced. That’s two whole rate hikes people! Wooohooo! I hope you’re screaming because this rollercoaster is going fast. More notable is one hike from the Bank of England in that time. Although that would only take back the post-Brexit vote August 2016 insurance cut. Not exactly what Kristin Forbes had in mind for her parting speech upon leaving the BOE this summer, where she warned:
‘Many of the factors that have justified keeping interest rates at emergency levels over the past few years have become less potent, and sterling’s depreciation has fundamentally shifted underlying inflation dynamics in a way that makes it more pressing to begin this voyage soon‘
The majority of the BOE are (yet?) to agree with her. The rise in inflation should be ‘looked through’. Just as it was when it was running at 5% following the financial crisis. (Is there much use in a target if it is either completely missed or completely ignored??) Even if the BOE were to start to pay attention, and start a hiking cycle, would that be good or bad for the economy? No wonder longer term rates remain low.
Somewhat surprisingly, the ECB’s Coeure quoted work by Forbes in his speech yesterday about the pass through effects of the currency onto inflation. Forbes uses a lower currency to argue for rate hikes; while Coeure uses “exogenous factors” to argue that a higher currency can be compatible with rate hikes. Here’s his chart of what’s driven the appreciation in the Euro:
‘there are three forces, of roughly equal strength, that help to explain the euro’s marked appreciation in recent months: improved euro area growth prospects, an exogenous component and a tightening in the relative monetary policy stance vis-à-vis the United States.’
In other words, it’s OK for the Euro to rally due to higher domestic growth, as that allows European companies to pass on the higher costs to the consumer and preserve their margins. It’s also OK if it’s exogenous because they can’t do anything about that. And they can’t do anything about US interest rates so that’s basically exogenous too. So, it’s all OK.
He goes on to wax lyrical about the joys of a flat interest rate curve, suggesting that this also means it’s OK for the currency to appreciate, because long-term monetary policy is still loose.
So the stage is set for the ECB. Any time they get a bit edgy about the appreciation in the Euro, they can shout that it’s NOT EXOGENOUS and it should fall accordingly, as the market pares back expectations of the taper. If they’re fine with the currency rising, say it’s exogenous, and let it fly.
In summary, we have central bankers approaching inflation and the exchange rate in whatever way they like, to make the argument for the monetary policy path they’ve already chosen to take. It’s no wonder so little is priced into those curves. The market knows as much as the central bankers do. Not much, basically. We like to think we understand the future. But it is truly the unknown country.
Throw into the mix that Janet Yellen may only have four more meetings left as Fed Chair, and all bets are off. Although… overnight we heard that Ivanka Trump met with Janet in the summer, just before her father went on to say Yellen was still in the running and told the WSJ ‘I like her. I like her demeanor. I think she’s done a good job…I’d like to see rates stay low. She’s historically been a low-interest-rate person‘.
If Janet Yellen doesn’t want the poisoned chalice then could it be #IvankaForFedChair?