This week central banks are responding to political pressure around price inflation (lagging economic indicator) with accelerated monetary tightening plans.
The central bank of Norway (Norges) doubled its policy rate to .50%, the Bank of England ended its bond-buying program and hiked its base rate to .25 from .10%, while the U.S. Fed doubled the pace of its Q.E. tapering–reducing to $60 billion a month, half of what it was buying in October–and ending it altogether mid-March, three months ahead of the previous plan; with three rate hikes forecast by the end of 2022. The ECB says it will slow its bond-buying to €40 billion a month in April from about €80 billion a month now, but left its policy rate unchanged at -0.5%. The Bank of Japan is up tomorrow; no tightening is planned. Now we have the next tidal wave of COVID upending plans and forecasts.
The Bank of Canada ended its bond-buying program in October, and 4-rate hikes are pencilled in by the end of next year (from .25 to 1.25). With 40% of new Canadian mortgages in 2021 taken with a variable rate (which increases with BOC rates)–at obscene ratios of price to income and rents–a 400% rate increase is no small feat. The larger question is to what extent forced selling prompts a surge in supply and self-feeding home price deflation with negative impacts on the economy and stock market, well within the range of probable outcomes.
The fragility inherent in highly levered households and businesses is one reason that we doubt the Bank of Canada will end up hiking to the extent planned (and presently priced into the Treasury market) next year. Central banks have been consistently over-optimistic on their economic forecasts, failing to acknowledge that their debt-adding policies serve to reduce future growth prospects.
Fed Chair Powell revived animal spirits yesterday when he acknowledged that falling asset prices would prompt the FOMC to rethink its tightening plans. That’s been their number one dovish catalyst for years now. But as Japan has reminded us since 1989, when stock, debt and property market bubbles burst together, no amount of central bank easing can stop or reverse the secular force of gravity on asset prices and interest rates.
In the end, much lower prices are not the enemy, they are necessary to restore financial viability, and valuable investment prospects rather than counter-productive speculative frenzy. Best to embrace the cure than waste more time and money trying to extend the unsustainable. The era of central bank worship is moving toward its predictable end.
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