{"id":110408,"date":"2021-03-24T11:33:35","date_gmt":"2021-03-24T11:33:35","guid":{"rendered":"https:\/\/fin2me.com\/?p=110408"},"modified":"2021-03-24T11:33:35","modified_gmt":"2021-03-24T11:33:35","slug":"column-central-banks-left-flat-footed-by-flexible-fed","status":"publish","type":"post","link":"https:\/\/fin2me.com\/markets\/column-central-banks-left-flat-footed-by-flexible-fed\/","title":{"rendered":"Column: Central banks left flat-footed by flexible Fed"},"content":{"rendered":"

LONDON (Reuters) – This time it is probably different – or at least for monetary policymakers and markets trying to track them.<\/p>

FILE PHOTO: The Federal Reserve building is set against a blue sky in Washington, U.S., May 1, 2020. REUTERS\/Kevin Lamarque\/File Photo<\/figcaption>

Fuzzier Federal Reserve targets are creating a fog for other central banks and for investors gauging the next upswing in the interest rate cycle over the coming years.<\/p>\n

The new average inflation regime hasn\u2019t been tried before and only the Fed has formally adopted it so far – leaving considerable uncertainty over how the Fed itself will behave, and also over how other countries react to a new mandate in Washington while they still observe the old ones.<\/p>\n

Desired or not, the dollar\u2019s still-dominant role in world finance means the Fed\u2019s trajectory remains as critical as ever for countries\u2019 financial policy and planning – especially in emerging markets, but in developed economies too.<\/p>\n

Last year\u2019s strategic review of its inflation goals gave the Fed substantial room for manoeuvre over when exactly to act on rising inflation.<\/p>\n

As it\u2019s no longer strictly bound to tighten credit when inflation is set to exceed the 2% target, due to a new long-term averaging of that goal, it can – and plans to – run the economy \u2018hot\u2019 as long as it deems the coming inflation spike temporary.<\/p>\n

It stressed that again over the past week – saying the majority of its policymakers still saw no rate tightening before 2024 – and indicated it would not change its stance without clear evidence of a shift in long-term inflation or employment developments rather than the mere forecasts of such.<\/p>\n

GRAPHIC: The Fed keys on inflation expectations –<\/p>\n

All that may make sense for today\u2019s America – but it\u2019s still from far clear how it plays out for the rest of the world.<\/p>\n

When it was rolled out last year in the middle of the pandemic, many assumed the change would simply lead to easier money for longer and a weaker dollar to match.<\/p>\n

That has its own overseas strains – but arguably more easily managed by emerging market central banks that can lean against exchange rate strength, build hard cash reserves and keep finance stable.<\/p>\n

But the initial thinking didn\u2019t quite capture the scale of the subsequent U.S. fiscal boost and the resulting rise in real bond yields this year that has confounded consensus and strengthened the dollar steadily.<\/p>\n

This seriously complicates the U.S. view, first and foremost.<\/p>\n

Not having played this particular game before, financial markets have in effect been left to make up their own minds. And their assessment to date, correct or not, is that the Fed will blink earlier and raise rates as soon as next year – sending real-inflation adjusted bond yields climbing as a result.<\/p>\n

Siding with the hawkish fringe of the Fed council, futures pricing appears to see such loose fiscal policy leading to rapid growth, re-employment and inflation that allow the Fed to start \u2018normalising\u2019 much sooner than it\u2019s currently indicating.<\/p>\n

\u201cIt\u2019s an outcome-based test,\u201d claimed Dallas Fed chief Robert Kaplan on Tuesday, adding he was one of the policymakers expecting a rate rise next year.<\/p>\n

FOGGY DUES<\/h2>\n

But that foggy view makes a mess of the outlook for central banks adjusting to the inevitable overspill of U.S. conditions – with a sudden, dramatic reversal of investor flows to emerging markets this month triggered by a spike in Treasury yields.<\/p>\n

Within a week of those outflows, Brazil, Russia and Turkish central banks rushed to jack up interest rates in the throes of a pandemic in order to head off currency weakness – with the scale of Turkey\u2019s tightening enough to see its central bank boss ousted at the weekend and the lira in tailspin again anyhow.<\/p>\n

GRAPHIC: Emerging Market currencies through the pandemic –<\/p>\n

\u201cInvestors didn\u2019t give up their bullish emerging market view until U.S. (10-year) Treasuries hit 1.6%,\u201d Morgan Stanley\u2019s EM team observed. \u201cBut the spike in USTs was a wake-up call to everyone and investors have become more cautious on EM since.\u201d<\/p>\n

But this second-guessing of the gradual evolution in Fed thinking is not solely an emerging market problem.<\/p>\n

The spike in U.S. real yields spilled over to Europe too, where a third wave of the pandemic is still in full swing and lockdowns still tightening. And this already forced the European Central Bank to step up its bond buying programme – less sure that euro zone fiscal spending will come close to Washington\u2019s.<\/p>\n

But at least the ECB already looks set fair to follow the Fed\u2019s strategy rethink toward more flexible inflation targets.<\/p>\n

The Bank of England is still theoretically bound by its government-mandated 2% point target for inflation and its chief economist and others are already chomping at the hawkish bit.<\/p>\n

Despite a dire year for the British economy and the trade sensitivity of any outsize sterling strength, futures markets see the BoE lifting rates before the Fed – partly because of its now stricter mandate during a reflationary period.<\/p>\n

GRAPHIC: G4 Policy Interest Rates –<\/p>\n

\u201cThere is a genuine worry around persistent excess inflation for some in the internal camp within the (BoE) and we think this will continue to play out over the next several months, especially given the Bank\u2019s symmetric inflation target,\u201d Deutsche Bank economist Sanjay Raja said.<\/p>\n

Offsetting factors include tighter UK fiscal projections that may allow the BoE to hang loose for longer, Raja said.<\/p>\n

\u201cThe bar for the BoE to tighten policy over the next two to three years may be high, though not entirely insurmountable.\u201d<\/p>\n

GRAPHIC: Emerging Market CDS rates over 12 years –<\/p>\n

The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own<\/em><\/strong>.<\/p>\n

Source: Read Full Article<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

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