While monetary policy normalization is beginning, it will unfold gradually over time, with rates moving from low levels. This is unlikely to pose a threat to global reflation, supporting global equities.
Global Market Strategist
Listen to On the Minds of Investors
Recently, yield curves have been on the move around the world. The short-end, in particular, has moved higher as investors brought forward their rate hike expectations due to persistently high global inflation. Investors should not paint all central banks with the same brush stroke as normalization will come in different shades: some central banks are already or close to being on the move, others will remain somewhat patient until next year, while others will remain firmly on hold. These nuances depend on each central bank’s credibility with regards inflation versus target, as well as whether sticky inflationary pressures are present (or not). A lot of action will continue to take place in yield curves, a tricky period for fixed income investing. However, opportunity exists for active managers to take advantage of mispricings. While a turn is occurring in monetary policy, it will likely unfold gradually and should not pose a threat to global reflation – a positive backdrop for global equities.
Global consumer inflation has been persistently high this year, moving up to 3.7% in September, the highest this year and above the ten year average of 2.2%. Global factors include high energy, food and goods prices as a result of supply and demand imbalances. These issues will take some time to resolve themselves, suggesting global inflation has yet to peak. Based on high for longer inflation expectations, investors have brought forward their rate hike expectations, with curves flattening. Are all global central banks on the move? Central banks will follow different timelines for lift-off, as well as subsequent rate hikes, based on two main variables:
- Each central bank’s credibility with meeting their inflation targets: was inflation too high, at target, or too low over the last cycle?
- Each country’s current inflation dynamics: are there elements of sticky inflationary pressures?
Taking these two questions together, a multi-speed race emerges:
- Front of the pack: central banks already hiking rates. This includes “high yielding” EM central banks that have low policy credibility because of a history of too high inflation (LATAM central banks, Russia, Hungary, Poland). Rate hikers also include some DM central banks (Norway, New Zealand, and perhaps the Bank of England soon). Here there is no credibility problem, but credibility success with inflation having been at target last cycle.
- Middle of the pack: central banks that are patient for now, but likely on the move next year. This includes central banks that have yet to see sticky inflationary pressures emerge (Canada and Australia). Here market pricing seems too aggressive, with Canada expected to hike four times next year and Australia three times. Lift-off seems a few months too early and a few hikes too many, but lift-off next year seems reasonable. The Fed also falls in this camp: not due to a lack of sticky inflation elements, but because of the short-fall of inflation last cycle.
- Back of the pack: central banks that are ways away from raising rates. This includes central banks that saw large short-falls in inflation versus target last cycle and still see a lack of sticky inflationary elements (European Central Bank, the Bank of Japan). Here investors have gotten ahead of themselves, pricing in the first rate hike by the ECB already next year. It is likely best to characterize these two central banks as “on hold” until 2023 or beyond.
Some short-end yields have moved up too far too fast and curves have flattened too much, an opportunity for managers to take advantage of mispricings. While monetary policy normalization is beginning, it will unfold gradually over time, with rates moving from low levels. This is unlikely to pose a threat to global reflation, supporting global equities.
Globally, investors have brought forward rate hike expectations
Market expectations for policy rates, calculated using OIS forwards
Source: Bloomberg, J.P. Morgan Asset Management.
Data are as of November 2, 2021.