Why are central banks targeting 2% inflation, and should they? This question seems to be on a lot of people’s minds at the moment, as it should given the likely difficulty in an achieving a perfect landing in inflation at 2%. Bloomberg’s Marcus Ashworth even asks the question that I suspect many economists or investors are thinking about at the moment; should the 2% inflation target be retired? And if so, how?
Read MoreMonetary policymakers have been scrambling in the past week to push back against the dramatic shift in market expectations for rate cuts next year. This is true for Fed officials—despite the clear dovish pivot in the December meeting—and particularly so for the ECB, where Ms. Lagarde and her colleagues have been hard at work to disabuse investors of the notion that the central bank will start cutting rates in the first half of next year. Are central banks right to lean into the prevailing market winds here? It’s all in the eye of the beholder. The chart below plots futures-implied policy rates for the Fed and ECB through 2027. The focus at the moment is on 2024, where markets see 150bp and 120bp worth of cuts from the Fed and ECB, respectively. That sounds like a lot, but then again, inflation is now falling rapidly. The question we need to ask is whether markets will be fed information over the next few months that will drive a shift in pricing. I am not sure, and if they aren’t, talk from policymakers will be cheap.
Read MoreI have a few speaking engagements coming up, prompting me to update my view on the world beyond the borders of the Eurozone, which makes up the day job. One trend that I am looking forward to present to, and discuss with, investors and capital allocators is the tension between signs that the inflation and interest rate shocks are now fading, in a cyclical sense, and the risk that inflation will stabilise above 2%, posing a challenge for monetary policymakers. Will they channel their inner Volcker or fudge the 2% inflation target?
Read MoreThe prevailing mood in global macro discussions seems to be as follows; inflation is past its peak, but it is set to remain a lot higher for a lot longer than initially anticipated, forcing central banks to continue hiking, keep rates higher for longer, or a combination of the two. The interest rate shock in the UK, as markets have adjusted their expectations for the BOE bank rate higher, and hawkish comments from the ECB are the two most obvious cases in point in developed markets. But a surprise hike by the Bank of Canada, and a larger-than-expected hike in Norway have added to the sentiment. We only really need the Fed to be forced into a hawkish turn to complete the narrative. This shift is important for investors. We are not just trying to calibrate when central banks will pause their hiking cycles—probably soon—but we’re also increasingly discussing, and pricing, how long rates will stay elevated, and whether central banks will have to resume hiking before they cut. Higher-for-longer, or #H4L, is already a trending hashtag on FinTwitter.
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