By Michael O’Neill
It was too good to last. The promise of transitory inflation that allowed the Federal Open Market Committee (FOMC) to ignore robust economic growth and rapidly rising prices while stubbornly adhering to its near-zero interest rate policy slammed into a global supply-chain derailment.
The FOMC was forced to acknowledge the reality of rising prices and on December 15, projected three interest rate hikes in 2022. That’s a big change from three months ago when the Committee couldn’t decide between leaving rates unchanged or raising them 0.25%.
They also announced they would speed up the pace of tapering, but that was expected.
Normally, one would expect Wall Street stocks to tank in the face of a surprisingly hawkish FOMC dot-plot forecast. But this isn’t a normal time; it’s December, and a slew of year-end influences are directing price action, chief among them, reduced liquidity. The US 10-year yield is a prime example of year-end distortions as prices stagnate in the 1.46% area, with many analysts believing year-end balance sheet reduction trades are suppressing yields.
The S&P index bounced from 4,612.00 to 4,701.00 following the Fed news. The Dow Jones Industrial Average (DJIA) traded similarly, closing 383 points higher. USDCAD erased its morning gains and plunged to 1.2833 from 1.2936. Those moves are textbook examples of buying the rumour, selling the news.”
And they should be ignored.
The post-FOMC equity rally is likely due to “short-covering,” as nimble traders book profits from this week’s sell-off. The same holds for USDCAD. The price action masks the reality that central banks have kicked off a tightening cycle.
Photo: Washington Post
Fed Chair Jerome Powell firmly believed in the notion of transitory inflation last spring due to a “decent amount of evidence,” but started changing his mind in September. That’s when CPI was more persistent, and it became important to move the timing of the taper program forward. He had an epiphany on the eve of the November FOMC meeting when the employment cost index surged to 5.7% q/q. He almost decided to increase the size of the taper but stayed the course until a strong employment report and another high CPI reading forced his hand.
The Fed reacted to rising inflation and employment gains, but the Bank of Canada (BoC) remains on the sidelines.
BoC Governor Tiff Macklem was far more sanguine about Canadian inflation at 4.7% y/y in November for the second consecutive month. He said it was expected but admitted it was well above target. He appeared to justify the BoC inaction to the high reading by noting, “inflation is a global phenomenon due to supply chain disruptions.”
He also said he expects inflation to remain elevated until the second half of 2022 when prices will retreat.
The Federal government renewed the BOC monetary policy framework. The BoC’s overriding mandate continues to be price stability, which “will continue to be the 2 percent mid-point of the 1 to 3 percent inflation-control range.”
The renewed mandate has an added wrinkle. “The Bank will consider a broad range of labour market indicators and will systematically report to Canadians on how labour market outcomes have factored into its monetary policy decisions.” In addition, “The Government and the Bank also agreed that monetary policy should continue to support maximum sustainable employment
To many, it sounds like a “dual mandate.” To others, it is a “duel mandate” as at any given moment, one of those factors will be fighting with the other for relevance (does anyone else hear banjo music?).
Mr. Macklem responded to a question about how the new policy framework differs from the previous one, by saying “it reaffirms what we are already doing.”
The new agreement advises the Bank to develop the modeling tools needed to take into account the important implications of climate change for the Canadian economy and financial system. Hmm, can you imagine the headline? “Record snowfall in Montreal forces Bank of Canada to slash interest rates”
The Fed and BoC are fully aware of the latest surge in Omicron cases domestically and worldwide. The BC Provincial health officer Bonnie Henry warned that Omicron cases could rise to 2,000 per day within six weeks, while other government officials discuss new restrictions. In Ontario, that number could be 10,000/day by New Year’s Eve.
Omicron could lay waste to the Fed and BoC outlooks, but if booster vaccines solve the problem, the rate hike rocket (and Alice Kramden) will go to the moon.