Posted on

The US Federal Reserve (Central Bank) announced last week that it will begin scaling back its $120 Billion monthly bond-buying programme by $15 billion per month (remember – if a Central Bank buys a bond off an Investment Bank it is giving money to that bank in exchange for the security. Providing funds to the bank in this way boosts the money supply and stimulates the economy!). This reduction in bond buying, although long expected, is a critical milestone for a US economy that is recovering from the pandemic and contending with surging inflation (October 2021 6.2% annual rate – the fastest pace in three decades).

The decision is the culmination of months of debate among Fed officials on the level of support the world’s largest economy needs as price pressures begin to extend beyond the sectors most sensitive to post-pandemic reopening.

The move corresponds with actions by a number of central banks around the world to tighten monetary policy, including the Reserve Bank of Australia and the Bank of Canada.

Markets expected the Bank of England to raise interest rates last week but the BOE confounded invesors and left its benchmark interest rate unchanged at an historic low of 0.1% even as it published its highest inflation forecast for a decade (5% annual rate by next Spring). The move surprised many investors with interest rates not immediately going up. It ignited a powerful rally, not just in the UK, but across global markets. The 10-year UK gilt sank 0.13 percentage points (basis points) to 0.94%. Short-dated government debt notched even bigger gains with two-year yields falling 0.21% to 0.48 per cent. The BOE communicated that interest rates needed to go up but not just now. That’s an awkward message.

The rally swept across the Atlantic with the US10-year yield falling 0.06 percentage points to 1.52%, and the two-year yield down 0.07 basis points to 0.41%.

The BOE decision came a day after Jay Powell, Chair of the Federal Reserve, signalled it was too early for a US rate rise, saying the central bank would be “patient “before acting. 

How did the US and Global markets react to the US tightening move? The reduction in the bond buying programme barely registered with financial markets!! Short-dated US government yields edged up on slightly and the S&P 500 stock index extended its steady climb (to broadly all-time highs) instead of falling! The muted reaction reflected not just the Fed’s painstaking six-month effort to prepare investors for the “taper” of its massive stimulus, but also chair Jay Powell’s insistence that it was still far too early to think about raising US interest rates despite widespread inflation. The Fed wishes to see maximum employment before such a move and still believes that the current sharp rise in inflation is a relatively temporary phenomenon associated with pandemic related supply /demand imbalances in the economy which will level off in time. Such ‘dovish’ (not ‘hawkish’) comments calmed investors nerves.

Market levels:

Stock markets in many countries are close to all-time highs looking at the economy beyond the pandemic. An exception is the UK which is still adjusting to both the pandemic and Brexit.

Bond yields remain extremely low looking historically but off the crisis driven extreme lows of last year.

Commodity price remains at multi-year highs as the global economy recovers as exampled by oil at $82 per barrel (c.f. $20 the depths of the Covid crisis last year). Gold – which is viewed more a a ‘safe haven store of value’ in difficult times is very static at just below $1,800 per ounce well below its $2,050 high last year.

There is little move in Foreign Exchange rates with little change in interest rates (a key FX driver!) in any part of the world with the GBP/US rate (known as ‘Cable’) trading around GBP/US 1.37 for many months – one of the longest periods of extremely low volatility. The US Dollar itself, when looking at the US Dollar Index (against a basket of trading partners) is trading at 94.6, the highest it has been for 1 year as investors view small rate rises in the future but only in the middle of its 3-year range of 89-103 as any rate rise will be modest. Market expectations are for at least two US interest rate increases in 2022, with the first arriving in the third quarter.