Central bankers are the 21st century pantomime villains, where the public perception seems to be they don’t know what’s behind them, let alone what’s in front of them. The fact that inflation rates in most countries in 2021-22 soared above target meant almost every central bank utterance was greeted with boos and hisses.
Yes, mistakes were inevitably made. We can say (with hindsight) that central banks sowed too many magic beans in 2020. And interest rates were kept too low through 2021, when there was already evidence for rising inflation and tighter labour markets.
But most central bank criticism was grossly unfair. In 2022, the world came face to face with an unfriendly inflationary giant for the third time in two years. There was little else central banks could have done. Indeed, in 2023 the Bank of England (BoE)’s models suggested that even with a crystal ball in 2021 telling them what shocks were coming, interest rates would have needed to break double digits to keep inflation at target. Such a move would also have pushed the unemployment rate into double digits, posing grave financial instability risks.
Oh no you didn’t …
Almost three years on from Russia invading Ukraine and we see many global risk assets at record highs, credit spreads near record tights, inflation and inflation expectations close to, or at, target, and unemployment rates close to historical lows (and at an all-time low in the eurozone). Central banks’ mandates are hitting inflation targets, protecting financial stability and/or maximising employment. Investors should be casting central bankers as heroes, not the villains of the show.
But no fable is without its moment of adversity and indeed the greatest opportunities for active fixed-income fund managers come when central banks make mistakes, when markets misinterpret their guidance, or when markets behave irrationally. Right now there’s great potential for all three.
Today we have one of the greatest market and macro consensuses ever seen. Hopes for ‘US exceptionalism’ with 3% growth rates forever are rife: long US equities and tech, long US dollar, bearish US treasuries on an outright basis and/or relative to other markets. Such heroic optimism is reminiscent of the bullish emerging versus developed market narrative from 2010-12, and that didn’t end well.
To read the rest of the column, visit the January edition of Portfolio Adviser Magazine