Global monetary policy is clearly in tightening mode with many central banks hiking interest rates
Risks have shifted and asset allocators should take notice heading into 2022
The Fed meets Wednesday and will likely signal important changes to traders as US inflation remains hot
There’s been a clear pivot in monetary policy from easing to tightening this year. 2022 sees this theme move from “interesting” to *important* for asset allocation as risks shift. Inflation continues to run hot around the world, particularly in the US. Friday’s CPI report was roughly in-line with consensus, but as inflation verified stronger than expectations throughout the year, the Fed is forced into an uncomfortable spot.
Taking a step back, it became evident to us earlier this year that risks to inflation were skewed to the upside. That view has gone from hypothesis to reality. Our Weekly Macro Themes report explores the timeline of increasing inflation expectations. The initial culprits of high consumer prices were base effects, backlogs, and bounce-backs in activity. Surging commodity prices—on pace for their best year in decades at +56 percent—was another driver.
Higher commodity costs and above-consensus inflation are macro themes we got right this year. Those concerning trends have already had an impact on monetary policy decisions.
EM and Small Countries Felt It First
The global policy pivot from easing to tightening has been something we’ve watched closely in 2021. Emerging markets and smaller nations were the first to hike rates. These countries tend to be more sensitive to ebbs and flows in global inflationary pressures. Our data show that the rolling 6-month count of small & developing country central bank rate cuts is at the lowest level since before the dot-com bust. More recently, bigger emerging market nations have tightened; two-thirds of EM central banks are in hike mode.
Global Monetary Policy Grows Tighter
Our featured chart is one familiar to subscribers, but it’s important to know where we stand heading into an important Federal Reserve rate decision on Wednesday. The global average policy rate (GDP weighted) dropped markedly after the Fed’s tightening cycle in 2018. The pandemic then brought rates to fresh record lows. Beginning in mid-2020, however, inflation risks were already creeping up, so policymakers took action. Fast-forward to today, and it’s almost the Fed’s time to increase interest rates.
Featured Chart: The Tightening Continues
Balance Sheet Binge Lessening
And it’s not just rate hikes. Central bank balance sheet growth rates are tapering off. Certainly the US Fed’s reduction in bond-buying has stymied G3 central bank (Germany, Japan, and US) balance sheet growth. Investors should care about these trends because monetary policy is going to be a clear headwind for global markets next year—perhaps more so for the US since they are later to the game versus many emerging markets.
Now Batting: Jerome Powell
The Fed steps up to the plate this week. According to the latest futures market indications, there’s just a 2.2% chance of a rate increase. That probability jumps to a measly 7.0% at the 26 January 2022 meeting. The real interesting action is set to unfold at the 4 May and 15 June meetings. The futures market predicts three hikes by this time next year. Fasten your seatbelts.
Bottom Line: Monetary policy turned hawkish for many small nations a year ago. The stock markets of those countries have generally struggled in 2021. With stubbornly high inflation and bond-buying programs already in taper-mode, the US grows ever closer to policy rate hikes. We’ll get a fresh reading from Chair Powell on Wednesday afternoon.
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