Central Banks Are Redrawing the Map Out of the Crisis Era

(Bloomberg Opinion) -- It all comes down to the final full week of 2021 business for the major western central banks to begin spelling out how they’re going to unwind almost two years of extraordinary stimulus. 

It looks like a green light at the Federal Reserve, a blinking amber signal from the Bank of England and a shade of crimson from the European Central Bank. Their decisions in the coming days will create the template for a reset after pumping trillions into the global economy since Covid-19 hit last year. 

U.S. November consumer price inflation that came in at a four-decade high of 6.8% makes it a slam dunk that the Fed will decide as soon as Dec. 15 to hasten the end of its quantitative-easing program to March from June. Of course the nuance in how it phrases what comes next and why will be relevant. A lower-than-forecast November non-farm payroll headline is expected to be no barrier to ending bond-buying sooner, as a re-nominated Fed Chair Jerome Powell seems to have shed his dovish wings quite smartly.  

For traders, the question is no longer “if” but “when” — when will the Fed start withdrawing it and when will it start raising its benchmark interest rate?

The dollar's strength is partially based on an expected higher rate environment with U.S. money-market rates pointing to almost three 25 basis point increases in 2022, starting in June. While equities have taken that in stride, the more pressing issue is the shape of the U.S. Treasury yield curve. The recent flattening, with the shorter end rising on the prospect of both more and faster rate hikes matched by 30-year yields dropping to the lows of the year — pointing to to a slowing economy struggling with reduced stimulus. The Fed has a small window — let's hope it uses it wisely after previous attempts to take back the largesse had to be rapidly reversed.

One clear beneficiary of a more hawkish Fed is the BOE, which has struggled badly in communication efforts recently, giving the perception it has attempted to get too far ahead of its U.S. counterpart in stopping stimulus. Recent speeches and interviews with Monetary Policy Committee members have, if it was possible, muddied the waters even further. A 15 basis point increase to 0.25% is in the cards sometime soon, but it might have wait until next year. One thing for certain is that its bond-buying program officially ends next week. But a giant 28 billion-pound ($37 billion) redemption due in early March is a potential risk  that could prompt an embarrassing — albeit brief — resumption of purchases.

No wonder Governor Andrew Bailey has a dilemma on his hands — runaway inflation combined with all manner of mitigating factors, such as Covid, to square away a split committee. Bloomberg Economics expects the MPC will pass on Dec. 16 and pick it all up again at the next quarterly economic review in February. Still, it would be a brave person to rule out a rate hike.

Less than an hour later on Dec. 16, the ECB has its big review on how to replace Europe’s pandemic bond-buying program, known as PEPP,  when it expires in March. Expect the usual exercise in semantics from the optics-obsessed governing council, but the replacement will surely look remarkably similar to its antecedent — probably smaller than its precursor but retaining its flexibility. At the same time, PEPP will also likely live on, with regular  reinvestment of maturing holdings to maintain its 1.85 trillion-euro ($2.1 trillion) size — a powerful stimulus tool on its own. 

President Christine Lagarde has been careful to brush away any thoughts of an interest-rate hike next year, despite rumblings from hawkish policy makers. That will become a more relevant issue later in the year if the economic recovery is sufficiently robust, even if inflation stays above its 2% target. In essence the ECB will want to change as little as possible while giving the impression it is being responsive and proactive.  It’s a dead stop with a lot of kerfuffle.  

So in some sense the natural order of the central bank caravan will resume next year, with the Fed controlling the direction of travel, the BOE slightly ahead, and the ECB having enough problems of its own to not really budge but will be watching the others with interest. Interest rate hikes are very much on the agenda, the big question of 2022 is how many and when.  

More From Other Writers at Bloomberg Opinion:

• The Next Fed Meeting Will Offer More Surprises: Bill Dudley
• What 'The Wizard of Oz' Tells Us About Inflation: Daniel Moss
• A Massive Yield-Curve Headache Awaits the Fed: Brian Chappatta

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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