Central bank policy continues to keep markets off balance

The continuous debate surrounding the prospect of a US rate rise continues to dominate market sentiment as US policymakers continue to gear up the markets for a further rate rise later this year.

The continuous debate surrounding the prospect of a US rate rise continues to dominate market sentiment as US policymakers continue to gear up the markets for a further rate rise later this year.

Last night’s comments from permanent Fed policymaker Lael Brainard acted as a neat counterweight to recent hawkish rhetoric from San Francisco Fed John Williams and Boston Fed Eric Rosengren.

It is certainly interesting to note that despite the recent hawkishness, markets are still only assigning a 22% probability of move next week, though the prospect of a move in December has increased to 57%.

What is more puzzling is why we are having the debate at all when you look at the trajectory of US GDP growth since Q2 2015 which has been slowly trending lower.

The Federal Reserve continues to assert that it is data dependant while at the same time trying to keep their options open, and while GDP growth is but one metric it is hard to escape the fact that while the labour market continues to be robust, the GDP numbers have continued to decline and could well do the same in Q3 if recent ISM data is any guide.

Why would any central bank look to continue to raise rates given the current trend in data, as illustrated above, and while inflation remains weak?

If this trend in GDP continues it is hard to see how the Fed can even contemplate a rate rise.

Contrast the narrative from the US Federal Reserve with that of the Bank of England who has become even more dovish, despite GDP growth that shows no signs of a significant decline, and where inflation is now starting to pick up.

The recent actions in cutting interest rates and implementing further QE looks even more bizarre when viewed through a prism of stable employment, a fairly robust consumer, stable wages growth and a decent recovery after a brief July Brexit wobble.

It is slowly becoming apparent that far from being a “bomb under the economy”, that Brexit is likely to be a process rather than the sudden shock a lot of people predicted it would be.

While it is true that no one currently knows what form Brexit will take, there will undoubtedly be both pros and cons to the process in the coming months and years, and that change will happen slowly and organically than quite suddenly.

The Bank of England would have been better served keeping their powder dry until article 50 gets triggered, thus giving them more flexibility in terms of any policy response.

Bank of England governor Mark Carney talks of being serene about current policy, and claiming credit for the August stabilisation in the latest economic data. Given that we’ve been consistently told that monetary policy operates with a considerable lag the Bank must have developed super natural powers in the last few weeks, if the cut in rates and QE has worked its way through that quickly.  

In terms of the graphs above you would be very hard pressed to tell which central bank was looking to raise rates and which one was looking to cut them, which reinforces the narrative that central banks have no better idea of what their next moves in monetary policy are likely to be than we have.

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