Attack of the Hawks: Seven Days That Killed the Easy Money Age

In the run-up to the landmark rate hike in May, Lowe had repeatedly assured Australians that rates would not rise until next year, a quirky prediction he is constantly reminded of.

Fed and Swiss central bank raise interest rates

But this week, he wasn’t the only central banker to be misled and resort to extreme measures he never thought possible.

In the days following Lowe’s primetime TV interview, the US Federal Reserve implements largest rate hike since 1994while the Swiss National Bank raised its key rate for the first time since 2007.

The Bank of Japan, meanwhile, has set the tone for a monumental battle with speculators as the first hints emerged that it will pull back from defending its ultra-low bond peg.

To add to the drama, the European Central Bank convened an emergency meeting as some member states, such as Italy, suffered from rising bond yields, adding to the specter of the 2011 sovereign debt crisis.

This was a week in which markets struggled with the reality that interest rates will have to go higher even if a recession looms and stock and bond markets fall further.

The frenetic seven days of high drama kicked off on Wall Street last Friday. Stock markets were confused all year as record inflation — fueled by government money and low interest rates, but exacerbated by war and disease — left the Federal Reserve behind.

Concerns about a recession

In June there was hope that the worst of thisthe inflation breakout was over as the US personal consumer spending index showed a moderation in price increases. Sales slowed as traders sought a turning point.

But those hopes were dashed last Friday morning when the U.S. government reported that the year-over-year rise in the U.S. consumer price index had risen to 8.6 percent — a 40-year high.

The Fed should act, and quickly, even if its actions were to trigger a recession. The stock traders knew it. the SP500 plunged 2.7 percent and when markets opened the following Monday, sales continued and fell another 3.9 percent.

When Australian markets reopened on Tuesday after the long weekend of the Queen’s birthday, it had two nightmarish sessions on Wall Street to catch up. the SP/ASX duly fell 5 percent on the opening, before recovering to finish 3.5 percent lower.

As a wave of sales from Australian bond and stock markets belted out, Governor Lowe taped an interview with the ABC that featured yet another revelation.

Only six more weeks after his team of economists published their latest forecaststhe inflation rate would have to be increased by more than one percentage point to 7 percent by the end of the year.

The result was clear: interest rates went up, but faster and faster than he could have imagined. If the RBA’s inflation target were between 2 and 3 percent, rates should at least rise to that level.

Getting the message out

And so Lowe had some explaining to do to the Australian public, many of whom would have to pay higher mortgage payments to lenders as rates climbed.

While Lowe was preparing for his interview Tuesday morning, the Federal Reserve was also working behind the scenes to get its message out. The Wall Street JournalThe company’s economic writers have been dubbed “Fedwatch” because they have historically been used by Fed chairmen to signal important moves.

So when the paper indicated the possibility that the Fed would raise interest rates, not by the expected half percentage point, but by 0.75 percentage pointmarket prices have shifted higher.

By the time the Federal Reserve announced its decision two days later, the market had moved to fully anticipate an increase in that quantity to set the Fed fund rate at 1.50 percent to 1.75 percent.

It was indeed the highest rise since 1994, but that led to some relief in equities as the market feared the rate hike could have turned out even higher.

Traders Received More Comfort from Fed Chair Jerome Powell’s Insurances that while a jumbo increase may still be needed at the next meeting, it would approach a target of 3.4 percent.

“We’re not trying to create a recession,” Powell said, noting that the price of commodities would have to moderate for that to happen.

The market calm only lasted so long. On Thursday evening, the Swiss central bank shocked economists by raising key interest rates for the first time since 2007.

Although interest rates remained negative, it would now charge banks only a quarter of a percentage point instead of 75 basis points for holding their cash.

A meaningful delay

There would be more, was the message from one of the more moderate central banks that had used negative rates for years to counter pressure on its currency.

However, on Friday, Wall Street sales resumed as markets returned to recession concerns. the SP500 plunged another 3.3 percent as reality set in about the task ahead of central banks.

The Federal Reserve would raise interest rates “until there is a significant slowdown in consumer price inflation,” said Singapore-based macro fund manager Nick Ferres of Vantage Point.

“In that context, a better way to frame the policy adjustment is for the Fed to keep raising interest rates until inflation slows or something breaks,” Ferres said.

On Friday, the series of extraordinary aggressive actions came to an end. The Bank of Japan chose to keep its ultra-low target for 10-year bond yields at 0.25 percent, despite the sharp decline in the yen, as yields in other bond markets have risen higher.

Leading up to the decision, speculators had targeted the peg by shorting Japanese bond futures, but the central bank gathered what it took to successfully hold the line.

Traders will no doubt be watching for the central bank’s determination in the coming weeks as Japan too must cope with inflationary forces that have been absent from its economy for decades.

“The positive development this week is that the Fed is finally starting to respond assertively to inflation,” Ferres said.

Interest rates markets have reacted to this week’s actions and may have finally reached the point where they have overestimated the magnitude of the rate hikes. After a chaotic week, markets expect the Fed funds rate to reach 3.8 percent in March next year and the Bank of England’s to peak at 3.4 percent.

But two of the world’s largest central banks are lagging behind. One of them is the European Central Bank, which has to face a dispersion of borrowing costs among European Union members as market rates rise.

Entrenched high inflation

“The European Central Bank is catastrophically lagging the curve and the Bank of Japan is following the ostrich approach to monetary policy,” Ferres said.

ANZ’s currency strategists say there’s a risk that central banks can’t do much.

“While central banks are trying to show their commitment to controlling inflation with bigger rate hikes, there are still few signs of a turning point approaching.

“The entrenched high inflation, driven in part by forces beyond the control of monetary policy, plus higher rates, are making an economic slowdown inevitable.”

For investors in stocks, bonds and even Australian homes, the reality is that the battle to tame inflation is outpacing the willingness to jack up asset prices.

“Financial markets are finally facing the harsh reality that they – financial markets – have never been part of the objective function of a central bank,” said one market analyst.

Fair Work Commission surprise

For Australia, it remains to be seen how wrong Lowe got it and how much he will have to raise rates. The day after his TV interview, Fair Work Commission lifts the minimum wage by more than expected, adding more fuel to the inflationary fire.

Interest rates markets now expect the Reserve Bank’s spot interest rate to rise above 4.25 percent in April next year, nearly a year before the central bank had initially considered going above 0.1 percent.

“The subsequent full reversal of the RBA’s commentary — accompanied by accelerated rate hikes — is not pleasing to anyone,” said Triple-T Consulting fixed income analyst Sean Keane.

“And Governor Lowe’s comments about the ABC ultimately didn’t do much to mitigate the criticism the bank faces.”

That criticism and discomfort can only increase over time. But Lowe and his colleagues on central banking around the world want the public to know that they have the determination to do what they think is necessary.

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