The sprint to raise interest rates to levels that cool demand will give way next year to an elevated dawdle. The next phase of tightening will be more nuanced, but no less weighty than what we have seen so far. The cost of a misstep will be significant as the global economy enters this next stage in poor shape.
The main task for central bankers will be to convince people that smaller increases will not necessarily lead to cuts. They may well presage a break, but those in charge will find it hard to say that their job is not done. For investors, this will require paying attention to the intricacies: sifting through the most important data at any given time, which central bankers are talking about, and how much it matters. As the trajectory of borrowing costs will become less predictable, there will also be significant implications for currencies. Will the dollar’s rebound continue, can the beleaguered yen be relieved, will China need to step up its efforts to cushion the yuan’s decline?
Traders got a taste of this new world on Thursday when the Reserve Bank of Australia announced a transition to 25 basis point hikes after a quartet of half-point moves. Yields on Australian debt plunged while yields on US and New Zealand sovereign debt also fell. “The case for slowing the pace of interest rate increases grows stronger as the level of the cash rate rises,” RBA Governor Philip Lowe said in a speech. In other words, we can’t go on this clip any longer. This is not sustainable, regardless of the pace of inflation.
The ability to step back and judge the impact of rapid increases in the rate of fire is where officials have always wanted to be. All over the world, they seem to have decided that the sooner they get there, the better. The crunch that could have happened in 2023 is now postponed to this year, Evercore ISI’s Krishna Guha and Peter Williams wrote in a recent note. As a result, the cycle could be generally over by Christmas, they said. (The company expects a 75 basis point hike in the Federal Reserve’s benchmark rate next week.)
This sounds like good news, but the potential for errors is significant. Hawk or dove, there wasn’t much discussion this year about which direction rates should go, or whether the pace should be reasonably fast. The differences were mostly marginal. Hike by 50 or 75? Are a few reasonably big steps at a regular clip better than big and even bigger? In the new environment, the choices may be pause, hike, or at least signal an intention to consider a decline, provided inflation moves in the right direction. It almost seems normal, except we haven’t had normal in decades.
St. Louis Fed Chairman James Bullard hinted at the change in outlook last week – after signaling support for a third straight 75 basis point jump at the upcoming Federal Open Market Committee meeting on September 21. policy rate,” he said in an interview with Bloomberg News. “And then it’s a kind of ordinary monetary policy: you can adjust a little because the data is against your objectives or keep it unchanged because you’re on the right track or decrease a little because that the data entered favorably for your purposes.
As extraordinary as the present times may seem – the highest inflation in at least a generation, the fastest increases in decades – the early 1980s were more extreme. Despite all the comparisons to the era of Paul Volcker, the legendary inflation-killing Fed chief, interest rates today are still relatively low and inflation lower. The federal funds rate reached 20% in early 1980; the upper end of the rate range is now 2.5%. Consumer prices jumped nearly 15% from a year earlier in March 1980. Last month they rose 8.3%, the Labor Department said on Tuesday. (The Fed’s favorite price gauge, the Personal Consumption Expenditure Index, climbed 6.3% in July from a year earlier.)
Some managers try to set the stage for variety. “We have a completely free hand,” said François Villeroy de Galhau, member of the board of governors of the European Central Bank, on Friday. It was a day after the ECB raised its key interest rate by three-quarters of a percentage point. “No one should speculate that this will be the magnitude of the next step – we haven’t created a new ‘giant habit’.” That doesn’t rule out another big move; ECB boss Christine Lagarde was careful to keep that in play.
There has been a superficial element in such denials of a prefabricated policy. The RBA has said more than once that the policy is not on “a pre-determined path”. Fed officials say no choice is on the table. Central bankers also say they are addicted to data. In a few months, they may even think so.
If this has been the year of the monetary history books, 2023 promises no fewer challenges. They can be of different nature. Agility, often promised but less often respected, will be the order of the day. Lowe said he received letters from members of the public thanking him for higher rates; life just got a little easier for those dependent on interest-bearing accounts. The rest of us should prepare for the trials of normality. More from Bloomberg Opinion:
• We still have an economic recovery, don’t we? : Daniel Moss
• The ECB wields a big stick against inflation: Marcus Ashworth
• Powell eyes good on next CPI report: Jonathan Levin
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was Bloomberg News’ economics editor.
More stories like this are available at bloomberg.com/opinion