Monetary Policy

This week the team at TwentyFour have been busy compiling our 2022 fixed income outlook, which will be published next week. There is no doubt we are confronted with a challenging set of circumstances, which will provide investors – not just in fixed income – with headwinds in the year ahead, and in particular we think during the first half.

So that’s the banks, rates, swaps and currency traders that all apparently got the wrong end of the stick. Explaining how you might arrive at a future monetary policy decision is a challenging and fine balancing act, but as Governor of the Bank of England that is of course one your jobs.

Speculation on the timing of the Bank of England’s first post-pandemic rate hike has been rife. But whether the BoE hikes rates later this week, next month or even waits until after year-end, it is worth thinking about what it will mean for the general public, a step away from the financial markets.

Following a turbulent week for rates markets, Eoin Walsh outlines what investors can expect as the Bank of England and other central banks meet this week.

Let’s not forget that the BoE dropped rates from 0.75% right down to 0.1% at the start of the COVID-19 pandemic back in March 2020, having only managed to put through two hikes in 2017 and 2018. It has changed course sharply before.

In the last month, global government bond curves have had a torrid time, with significant steepening seen across US Treasury, UK Gilt and German Bund yields.

On Wednesday, the Fed moved one step closer to tapering and even put quite a clear timeframe for it, while on Thursday, the Bank of England openly talked about rate hikes.

With ample job openings, inflation well ahead of target, financial conditions that are certainly not tight and strong economic growth, the obvious question is what does the Fed need to see to finally start tapering its asset purchases?

Whether the Bank of England halts all purchases in August or merely begins to slow the pace of purchasing later in Q4 this year, by 2022, less technical support will exist for gilts.

Given the magnitude of the amounts involved we do think there is potential for some temporary volatility in the US Treasury market as the volumes change. We will be keeping a keen eye on both in the months ahead.

While we don’t expect any material spread widening in the near term, we remain extremely wary of higher duration bonds given our view that the potential persistent inflation suggested by recent data isn’t priced into US Treasury yields, which currently sit around 1.58% at the 10-year point.

After unleashing the strongest combined emergency package we have ever seen in 2020, central banks are now entering perhaps the most challenging phase of their COVID-19 response, trying to balance the economic recovery while at the same time having to reassure the markets they can control the threat of runaway inflation.