John Silver: “Wait a minute, listen to me for a while, Jim Hopkins, you have what it takes to accomplish great things, but you have to take the helm and chart your course, and you have to follow it, even in a storm ... And when the time comes you will test the quality of your sails and show what you’re made of and, well, I hope to be there, enjoying the splendor of the light that you will emanate that day. “
Quote from Treasure Planet, 2002 animated film directed by Ron Clements and John Musker.
Just like in John Silver’s speech, faced with the inflation “storm”, the Federal Reserve intends to take the helm and chart its course. At this month’s meeting, President Jerome Powell - who certainly has “what it takes to do great things” - explained the central bank’s new strategy. And although it has veered towards a hawkish stance, the markets are reacting in a disciplined manner. The Fed’s projections regarding future rate changes are now in line with the forecast of three hikes in 2022 (up to three months ago there was only one).
And the decision to plan the end of Quantitative Easing and the expansion line did not create chaos. From January, purchases of government bonds will be reduced by $ 20 billion a month, and those of mortgage-backed securities by another $ 10 billion. The reduction will continue at this rate, which is the double of what was decided at the beginning of November until reaching zero in March.
The compound reaction of the market to the Fed’s orientation change can also be explained as a satisfaction, in the face of persistent inflation data, of decisions that confirm the credibility of the institution and its ability (and willingness) to fulfill the stability mandate of prices. Furthermore, it is not excluded that the soft line of tolerance, now shelved, could be readjusted if the economic recovery turns out to be less solid than expected or inflation falls back more quickly than expected.
From now on, however, the US central bank’s focus will be on wage inflation. In particular, the dynamics of real wages (i.e., net of inflation) will be monitored with the utmost attention, whose growth must not exceed gains in terms of productivity, otherwise, a new “storm” of inflationary spiral could arise. Within this context, Pictet Asset Management analysts have issued a warning: “This exceptional economic cycle, marked by the intermittent pandemic shock, is difficult to interpret in all its macroeconomic implications”. Therefore you have to get used to the new routes of central banks and the volatility that could arise from them.
Focusing on Europe, it should be emphasized that the ECB is charting a different course from the Fed. The Institute led by Christine Lagarde has reiterated that no rate hikes are expected and that the reduction of the expansionary policy will be carried out in a very mitigated manner. On one hand, the ECB has announced that the extraordinary program PEPP (Pandemic Emergency Purchase Program) will end in March 2022, thanks to which government bonds worth around 60-70 billion euros have been purchased (from last year to today) every month.
On the other hand, however, the Institute explained that the APP (Asset Purchase Program), which is the plan for the ordinary purchase of government bonds, will continue until 2024 and indeed will be strengthened. In the second quarter of 2022, the European Central Bank will increase the funds from 20 billion to 40 billion euros per month, and then reduce them to 30 billion in the third quarter and bring them back to 20 from October 2022.
On the inflation issue, the Eurotower - which sets a level of less than 2 percent as a target for the eurozone countries - argues that the values are destined to grow also in 2022 but with a gradual slowdown that will lead to normalization in 2023. And it is this forecast that influenced the decision to keep rates unchanged; Lagarde said she believes inflation to fall without ECB intervention and that “a rise in interest rates now would not affect the inflationary shock that is hitting the European economy, but would affect household disposable incomes, putting a brake on recovery». To those who fear a Eurotower that is too dove, Isabel Schnabel, member of the Executive Committee, had already answered last month: “If we thought that inflation could stop stably above 2 percent, we would react without a shadow of a doubt.” But at the moment the European storm seems manageable.