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“We wouldn’t want to surprise markets”

Tapering, so what? Market reaction to the long-awaited start of the Federal Reserve’s trimming of monthly bond purchases has been muted but positive. Stocks in Europe and US are at record highs – tapering is not tightening. The Fed managed to spend months carefully guiding the market to expect this move, by which it will take 8 months to reduce its $120bn-a-month QE programme, at a rate of $15bn-a-month; it’s not about to let market expectations for an interest rate hike get out of control. Still the Fed is still behind the market on this one and could be forced in to raising rates sooner than it expects. Jay Powell urged patience and caution, and seems to have largely pulled of the trick of not tying the tapering timeline to a provisional lift-off date for rates.

“Our decision today to begin tapering our asset purchases does not imply any direct signal regarding our interest rate policy. We continue to articulate a different and more stringent test for the economic conditions that would need to be met before raising the federal funds rate,” Powell said.

Both the dollar and stocks rose, with Wall Street achieving yet another record high and European stocks marking fresh record highs again this morning. Shorter dated bond yields were steady, US 2yr yields up a fraction at 0.47%, whilst the bigger move was seen further out the curve with 10s hitting 1.6%. That would be the kind of reaction Powell wanted – as far from the taper tantrum of the past as you can imagine.  As he said in the press conference, the Fed “wouldn’t want to surprise markets”.

What we did see was the Fed trying to shift the goalposts a bit on the inflation narrative. That’s important since it indicates it’s not rushing to hike to combat inflation, and in no hurry to raise rates. He explained that “transitory” for the Fed does not mean “short-lived” but rather that “it will not leave behind permanently – or very persistently higher – inflation”. This takes us into the arena of ‘long transitory’, which is a convenient intellectual get-out for the Fed without it needing to admit it got the inflation call wrong in the first place. On the labour market, Powell said there is “still ground to cover” to reach “maximum employment”.

Bank of England

Today the Bank of England is expected to raise rates, but that does not mean it will. It’s going to be a tough call as the nine members of the Monetary Policy Committee are not singing from the same hymn sheet. There are possibly three main outcomes from today’s vote – hiking 15bps and no attempt to push back on market expectations for future rate rises; a hike with a pushback against expectations for further hikes; or no hike. The ‘no hike’ outcome could also be split into one in which the Bank signals readiness to move next month, or one without such a signal.

As noted a couple of weeks ago in our preview, whilst some are worried about inflation, it’s all that clear if the hawks have the votes.

The MPC is relatively evenly split in terms of hawks and doves, so it is not abundantly clear if the recent messaging from some members – albeit including the governor – matches with the votes.

Bailey has sounded hawkish, and we know Ramsden and Saunders are itching to act. Huw Pill, the new chief economist replacing Andy Haldane has also sounded hawkish, though less so than his predecessor.

Commenting after UK inflation expectations hit 4% for the first time since 2008, he said: “The rise in wholesale gas prices threatens to raise retail energy costs next year, sustaining CPI inflation rates above 4 per cent into 2022 second quarter.” We place him in the ‘leaning hawkish’ camp.

On the dovish side, Silvana Tenreyro is highly unlikely to vote for a hike next month, calling rate rises to counter inflation ‘self-defeating’.

Deputy governor Broadbent said in July that he saw reasons for the inflation tide to ebb. The spike in energy prices since then could lead him to change his mind but for now we place in the ‘leaning dovish’ camp,

Rate-setter Haskel said in May he’s not worried by inflation, and in July said there was no need to reduce stimulus in the foreseeable future. He goes in the Dovish camp with Catherine Mann, who said last week that she can hold off from raising rates since markets are doing some of the tightening already. “There’s a lot of endogenous tightening of financial conditions already in train in the UK. That means that I can wait on active tightening through a Bank Rate rise,” she said.

That leaves Jon Cunliffe somewhat the swing voter. In July he stressed that inflation was a bump in the road to recovery.

Dovish Leaning dovish Centre Leaning hawkish Hawkish
Tenreyro

Mann

Haskel

Broadbent Cunliffe Pill Saunders

Ramsden

Bailey

We look to see whether the recent spike in inflation and inflation expectations has nudged the likes of Cunliffe, Pill and even Broadbent to move to the Hawkish camp. It seems unlikely that governor Bailey would have pointed the market towards quicker hikes if he did already have a feeling for the MPC’s views on the matter. He had ample opportunity to push back against market expectations but didn’t, which favours a dovish hike today, which is likely to be negative for sterling – though we note the dollar is topping at recent resistance and could pull back.

Sterling looks bearish still and little the BoE can now do for it with the hikes priced in – only disappoint. Near-term resistance offered by the 20-day SMA at 1.37, bearish MACD crossover still in play calling for retest of the 61.8% retracement around 1.3560, which was the mid-Oct swing low the provided the base for the rally through to Oct 21st.

GBPUSD Chart 04.11.2021

Inflation

Inflation is here and here to stay, which is probably why the Bank will ultimately raise rates. Yesterday’s services PMI indicated that while companies reported a sharp and accelerated rise in business activity during October, operating expenses and prices charged by service providers increased at the steepest rates since the survey began in July 1996.

The IHS/Markit report noted (emphasis mine): “Rising costs for energy, fuel, raw materials, transport and staff all contributed to increased prices charged across the service sector. Moreover, the rate of output charge inflation reached a fresh survey-record high in October. Service providers again noted that strong demand conditions and constrained business capacity had resulted in the swift pass through of higher input prices to clients.”

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