A Fed governor, Christopher Waller, made it clear, in a speech to the Institute for Monetary and Financial Stability in Germany on Monday, that the mood within the Fed is hardening.
“I am advocating 50 (basis point hikes) on the table every meeting until we see substantial reductions in inflation. Until we get that, I don’t see the point of stopping,” he said.
The central banks aren’t going to act as the safety net for investors that they have been for more than a decade so unless or until the exogenous shocks that have increasingly shaped markets this year disappear the markets remain, or at least should remain, “risk-off” environments.
The challenge for the Fed and other central banks, including the Reserve Bank, is that inflation isn’t being driven by demand but (reminiscent of the oil shocks of the 1970s) by supply-side pressures.
The pandemic’s disruption of supplies has continued, overlaid by China’s harsh “zero COVID” policies and by the impact of the war in Ukraine on energy and food supplies.
Food prices are rising as grain prices soar amid supply shortages. The oil price, which started the year below $US80 a barrel, had been subsiding from its peak of more than $US127 a barrel in March but has surged again to hit $US121.67 on Monday.
With the European Union finally agreeing on Monday to ban seaborne imports of Russian oil – about two-thirds of Russia’s oil exports – the supply issues in the oil market can only worsen. Russia is the world’s third-largest oil producer, supplying about 10 per cent of the world’s oil.
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There is no quick fix for the impact of the war on grains and oil supplies and no certainty that the slight easing of restrictions in Shanghai at the weekend will lead to a permanent re-opening nor that China’s efforts to stimulate its flagging economy will be successful while zero tolerance for COVID remains its policy.
The Fed and RBA can depress demand by raising rates until they push their economies into recession, or near-recession. Fixing broken supply chains or ending the war in Ukraine or convincing China to live with COVID are beyond their remits.
Monetary policy is a crude instrument but raising rates and withdrawing liquidity from their systems are the only tools central banks have to respond to inflationary outbreaks.
With wage-price spirals on the horizon – the employment market in the US is tight, as it is here – and companies are already passing on the increased costs generated by the supply chain issues – it may take a series of unrelated positive outcomes for the war in Ukraine, China’s economy and the pandemic to have any impact on the supply-side pressures and to avoid the major economies being forced into recession by their central banks.
“I am advocating 50 (basis point hikes) on the table every meeting until we see substantial reductions in inflation. Until we get that, I don’t see the point of stopping.“: US Fed governor Christopher Waller says the central bank is determined to rein in inflation. Credit:Bloomberg
It’s not clear that markets have priced in the most likely scenario – that the central banks will keep tightening monetary policy and will have to over-reach their targets for shrinking demand in their economies in order to bring it into line with the reduced supply.
“Stagflation” — a period of low to negative economic growth while inflation remains at elevated levels — is a real prospect and would further damage already-pressured living standards.
The central banks aren’t going to act as the safety net for investors that they have been for more than a decade – there is no longer a “Fed put” for investors – so unless or until the exogenous shocks that have increasingly shaped markets this year disappear the markets remain, or at least should remain, “risk-off” environments.
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So far we’ve only seen the very start of the process of central banks reversing policies that had been in place and which have supported financial markets and asset values generally since the 2008 financial crisis.
Given how inflated financial assets were by those policies, and how far and hard the central bankers might have to go to bring 40-year high inflation rates under control within such complex and volatile global circumstances, those who ventured back into equity markets last week were either very brave or quite foolish.
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