Central Banks take different paths

The Federal Reserve takes a hawkish turn

Having failed to anticipate the current surge in inflation, the Federal Reserve took a hawkish turn last Wednesday as was widely expected, implicitly ditching the monetary policy rule it had introduced just a few months earlier. The Fed monetary easing proved excessive when combined with strong fiscal spending as the supply chain came under strain. Crucially though, it was right to overdo it as the future was far from clear. Ahead of us is still a few months to time the peak in inflation and watch for any sign of a wider wage inflation spiral.

The ECB hopes it is right

The ECB stated that it was very unlikely to hike rates in 2022, and it plans to increase temporarily (in Q2) the standard APP Bond Purchase program to avoid a brutal shock when the flexible PEPP program is wound down in March 2022. The ECB will then taper down the increased APP program. Finally, as a risk management measure, the ECB is giving itself flexibility with the reinvestment of the PEPP program. Even with such a dovish stance, the ECB sounded a note of caution on inflation with an eye on a potential wage inflation spiral. The ECB appears to be hoping that global demand will cool down as the Fed tightens monetary policy and China slows down. It is a dangerous strategy and we expect that over time, the ECB will turn steadily more hawkish but remain behind the curve relative to the Federal Reserve.

What does it mean?

Tighter monetary policy eventually leads to an economic slowdown. The question is whether excessive risk taking will translate into a more pronounced slowdown as valuations adjusts. This might be the case in China, though it will likely take another year to see this in the United States and Europe. It suggests preferring short-duration leveraged positions such as Covered Bonds.

Note: Expectations of Fed tightening have increased significantly though the market is unsure whether the Fed will be able to slowdown inflationary pressures without excessively slowing down economic growth.

Source: Nordea Investment Funds S.A. and Bloomberg

Note: The Fed dotplots are the forecasts made by FOMC members. It is in part a tool in guiding the market, the chairman has tried to reduce as a communication tool.

Source: Nordea Investment Funds S.A. and Bloomberg

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