E Inflation Underlines The Dilemma Facing Central Banks

Central bank watchers everywhere seem to be on high alert for any signs of monetary tightening. Investors are parsing bankers’ statements for clues as to when rates will rise. Whether by design or accident, it seems that these central banks are giving off vibes that rates are about to take off. Taking a world tour of central bankers, we note that:

The Fed has consistently spoken of the need to “normalize “rates, that is to get the real rate of interest into positive territory; in addition, the Fed has signaled that it wants to shed its bloated balance sheet of government and agency debt;

The European Central Bank ‘s President Mario Draghi delivered a somewhat bullish statement of the EU’s growth prospects, saying that “reflationary pressures” have replaced deflationary ones of the recent past; investors bid up the Euro as talk of tapering of the ECB’s huge balance sheet is being reported widely in the financial press;

The Bank of Canada’s Governor Poloz stated that the emergency rate cuts issued in response to the collapse of the oil prices “have done their job”; immediately, analysts priced in a higher probability that the bank rate will be boosted at the upcoming meeting in mid-July;

The Bank of England is struggling with a weakening pound and great uncertainty about the outcome of the Brexit negotiations; yet, some investors detect that the BoE will soon move in the direction of tightening; and,

The Bank of Japan is facing an unheard of condition of full employment (along with selected labour shortages) with virtually zero inflation, if not outright deflation; none expect the BoJ to change policy in any foreseeable future.

Bond markets in Europe and North America sensed that there may be a systematic shift in monetary policy towards raising rates. The 10 year bond term rates moved up about 15 bps in North America and both Gilts and the Bunds moved up smartly at the same time.The currency markets took their cues from the central bankers the past week as the Euro and Canadian dollar gained at the expense of the US dollar.