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“...and how many times can a man turn his head, and pretend that he just doesn’t see"

- Bob Dylan, Blowin' in the Wind

Last week we talked about the complexities of the global macro backdrop at the current juncture. Complexities that are starting to seem more than transient.

Perhaps nowhere is the near-term situation more complex than in the UK, where the difficult choices we have previously outlined for the Bank of England (BoE) have only got more complicated. Markets are now pricing such a rapid rate repricing at the front end, for the BoE to get ahead of inflation and likely more importantly medium term inflation expectations, that they are simultaneously pricing subsequent cuts (SONIA curve inverts at the one year point after steepening very sharply at the front end, over recent weeks).

Clearly, the BoE needs to defend the primacy of their inflation mandate and act so as to prevent the de-anchoring of medium-term inflation expectations. However, given the unclear employment transition from the furlough scheme, the ambiguity of communicating a rate hike while quantitative easing (QE) purchases are continuing (if only for a few more weeks), and even the threat of renewed Covid restrictions over winter (if the public do not heed the Health Secretary’s warnings), the implications of a rate hike to defend the mandate of the BoE are not clear, especially not for growth. This is also what the SONIA pricing suggests.

However, the threat of inflation remains clear and present. Indeed, it has likely become the number one concern for developed markets over recent weeks; you could make the case that it has been the focal point of emerging markets for some time now.

In the US, it is very possible that the Federal Reserve (Fed) follows the BoE and becomes more obviously concerned about a more persistent and pernicious inflation – one that could no longer be so clearly dismissed as transitory; one with sufficient risk of second round effects and a destabilising of medium term inflation expectations that the Fed is forced to act. This may only be a subtle emphasis at the November Federal Open Market Committee, in conjunction with a move to taper the QE programme purchases. However, much like the BoE, the Fed are likely to ‘chase up’ the USD in a similar fashion.

Ultimately, as we have noted a number of times recently, the US has substantial monetary accommodation relative to pre Covid (certainly far more than their global peers), such that we do not see a scenario where the Fed drives a more hawkish repricing of the front end of the US curve that would undermine near term growth expectations – at least not beyond the still-transitory phenomena of supply bottlenecks and delta constraints. The US growth backdrop likely remains positive, as pent up demand, past and future substantial fiscal stimulus and an acutely easy monetary stance continue to support demand, the USD and US equities - even in a front-end rate repricing.

Next week, we get the European Central Bank (ECB). The October meeting was meant to be a non-event. There are no new staff forecasts to discuss. And the policy decision – the Q1’22 Pandemic Emergency Purchase Programme purchase pace and the transition of the programme into the existing asset purchase programme framework, after the March expiry – was pushed to the December meeting, following the decision for Q3 in September.

However, in what seems like a lifetime ago but is only a few weeks, since the last ECB meeting, there has been a dramatic energy price increase (one that has likely widened growth divergence across the region due to its asymmetry), an intensification of supply chain disruption (hitting Europe’s auto and manufacturing base hard – with sharp downward revisions to 2021 growth) and even rising longer term inflation expectations, with markets pricing in an, albeit modest, rate rise in 2022. Yet the ECB has shown that it is the continued desire of the ECB’s top table to push back against any market expectations of normalisation and play down fears of inflation-induced tightening, favouring instead continued foot to the floor easing.

To cap it all off, the longstanding Head of the Bundesbank (passed over for the top ECB job in favour of the current president, and importantly, a long-term inflation hawk), has resigned his post. There is a clear irony, that just as the world faces the first real threat of actual inflation for the first time in decades, the man who has dedicated his career and his focus to monetary prudence and the maintenance of central bank inflation fighting credibility, has felt it time to move on. It is not clear what his motivations are at this time, but in his parting messages, he emphasised his wish that the ECB “must not lose sight of prospective inflation dangers” and “monetary policy must not get caught up in fiscal policy”. Conspiracy theorists may argue that Modern Monetary Theory is lingering over the Governing Council (and let’s not forget a period of inflation would certainly help address the elephant in the room – eurozone debt levels).

To paraphrase Dylan, perhaps he was fed up of turning his head and pretending he just doesn’t see. Either way it seems the ECB may have just lost their most experienced sailor, just as the wind starts blowin’…

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