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Welcome to what Goldman Sachs calls “reflation despair.” For politicians and investors, this will be a nauseating and probably long ride.
The embarrassing reset occurred because it turned out that the inflation dragon had not been slain after all, even though markets had effectively proclaimed victory at the end of last year.
A punchy reading on consumer price index inflation in the United States can be considered unfortunate. Two seem careless. Three months out of three, like the current ones, are impossible to explain. The fact that the increases are modest and that this is not the Federal Reserve’s preferred measure of inflation is not enough to negate the signal, especially when combined with this week’s standout US retail sales data.
The big bet on rate cuts – and it was huge – is dead. At the start of 2024, the expectation was for six, maybe seven US rate cuts this year. It seemed silly even then, but it’s unfolding in a humbling way. Today the markets are outlining one, maybe two.
The Bank of America postponed the request for an initial cut by the Fed from June to December: a huge leap forward for an adjustment that generally occurs in increments of one or two months at a time and which opens up the real possibility that the cuts may not come at all this year. Goldman Sachs, once in the “five cuts” camp, has now gone from three to two, starting in July instead of June. Bond prices have fallen and are dragging stocks down with them.
How did everyone get carried away with the idea that rates were ready to be cut aggressively? It certainly seems like it’s time for a little introspection on all sides.
The main reason is that we are trapped in old ways of thinking, convinced that inflation will fall back to something that seems like a norm and that central banks will be quick to retreat into the hot waters of low interest rates that have dominated the post- crisis. until war and plague came. The reality is clearly more complicated than that.
For a while, there was a clear dividing line: Markets repeatedly flinched at signs of potential cuts, and central bankers again stifled them, reminding investors of their sacred duty to keep inflation in check. It seemed as if markets were from Mars and politicians were from Venus, looking at the same facts and drawing completely different conclusions.
For Jean Boivin, former deputy governor of the Bank of Canada and now global head of research at the BlackRock Investment Institute, further complications arose at the Fed’s rate-setting meeting in December. Subsequently, the central bank kept rates unchanged, but also did not dismiss growing market expectations that they would begin to fall rapidly, and indeed gave indications that it would cut three times in 2024.
“Central bankers have been behaving more like traders lately,” Boivin said. “They were aware of the uncertainty, but said they would take a gamble. They bet everything on immaculate disinflation. . . That Mars and Venus thing has changed. Or maybe they’re both on Venus.
To be fair to bond investors, few genuinely believed in seven cuts, but probably three or four, plus some hedges against a truly terrible recession. And in fairness to central bankers, steering monetary policy through a storm of shocks, including frozen supply chains and war on European soil, is no easy task.
The soul searching has begun. The Bank of England, for example, just concluded a review led by former Fed Chairman Ben Bernanke, who concluded that British policymakers had demonstrated “significant shortcomings” stemming from faulty thinking, outdated software and difficulties communicating clearly . The Fed has now also acknowledged that it is taking “longer than expected” to tame inflation.
It’s a rich elixir for brash politicians eager to pin the blame for rising inflation and declining living standards on independent monetary policymakers, and for investors eager to find someone to blame for their market missteps .
The reality is that this is what data addiction really looks like, the mantra of politicians. Rate makers are less able to give investors granular guidance on what happens next, because they are as easily swayed by economic data as the rest of us. They may never fulfill their mission of being boring again in our lifetime. As long as deglobalization, the green transition and heavier fiscal spending on sectors such as defense persist, inflation will fluctuate and cause sharp changes in sentiment. We all need to learn to live with unstable narratives and markets.
katie.martin@ft.com