MIKE DOLAN: King Canute and the optics of the interest rate tide

London — Like medieval King Canute’s unsuccessful attempt to command the incoming tide to stop, central banks’ attempts to push back against swelling bets on interest rate cuts seem forlorn.

But like the story of the old Anglo-Norse monarch, there’s more to these old yarns than meets the eye.

For many, the apocryphal tale of Canute ordering the tide to stop just illustrates foolish overconfidence in regal power. Yet chroniclers insist the wily king was in fact just showing his courtiers the limits of his earthly majesty in the face of overarching forces of god and nature.

Stretching the analogy at bit, a similar nuance for central banks is important looking ahead to 2024.

After acknowledging the interest rate cycle has turned, many Federal Reserve and other central bank officials now feel compelled to stop the tide from coming in too fast, scrambling to warn markets not to overstep the mark.

On the face of it, that seems a bit futile — at least trying to frustrate long-maturity bond yields from pricing what many will reasonably see as a full cyclical downswing in rates over the years ahead.

The Fed and others officials could prod and poke futures and short rates pricing by protesting against the assumption of rate cut timings. But stopping a dash for 10- or 30-year coupons is a different matter altogether and largely outside its control as it hinges more on how the economy unfolds.

Yet the Fed would surely have known last Wednesday exactly what changed projections for 2024 would unleash. And with armies of researchers and market liaison staff, it would also know that rhetorical pushback on economically sensitive long rates won’t cut it once an easing cycle is started.

After all, markets were already priced for 100 basis points (bps) of cuts when the standing Fed forecasts still had a median “dot” pointing to one more hike in 2023. The fact they’re now pricing up to 150bps of cuts in 2024 when the Fed policymaker average has shifted to cuts of 75bps is not greatly surprising.

So, much like Canute, the Fed — and its counterparts in continental Europe where inflation is already back near target — may just be playing a game of optics while acknowledging the direction of travel in markets is both a little beyond their control now and possibly what they wanted anyway.

Perhaps.

European Central Bank (ECB) board member Isabel Schnabel’s dramatic switch from hawk to dove earlier in December is a case in point — and any attempt at stanching the market flow after that switch may just seem mischievous.

Publicly at least, central bankers often want to distance themselves from markets altogether, preferring to see price shifts as a force of nature as changeable as the wind or indeed the tide.

“One of the things I’ve learnt is I don’t control markets and so they’re going to do what they’re going to do,” Richmond Fed president Thomas Barkin opined on Tuesday.

And even though the Fed will insist it is “data dependent” from here, Barkin seemed pretty comfortable with the state of play and what the Fed is indicating.

What is more, the “higher for longer” mantra prevalent at most top central banks for so long has shifted subtly too — to “more restrictive for longer”.

“It will be important for monetary policy to be restrictive for an extended period,” Bank of England (BOE) deputy governor Sarah Breeden said on Wednesday.

But of course “restrictive” is not strictly where rates are now.

If rates above the Fed’s unchanged long-term neutral rate of 2.5% are technically bearing down on the economy, then that leaves a lot of potential easing while remaining “restrictive”. Even matching the markets’ slightly caffeinated 150bps would leave policy rates at a historically bruising 4%.

What is more, further disinflation only lifts the real policy rate from here as the economy slows, requiring some offset just to keep real rates where they are.

And in the end, the Fed has no interest in triggering a recession if inflation is contained — its dual mandate actually dictates otherwise.

San Francisco Fed chief Mary Daly made that point crystal clear this week in an interview with the Wall Street Journal, pithily dismissing any suggestion of some scorched earth monetary policy. “We don’t give people price stability but take away jobs,” she said.

So what then of the market thinking that Chicago Fed boss Austan Goolsbee this week claimed to be “confused” by the relentless tide itself?

In some respects, central banks allowing markets to ease credit conditions into the coming slowdown while appearing to talk tough could be seen as an impressive attempt at fine tuning the fabled “soft landing”. With the full force of past policy rate hikes yet to hit, bond market easing now could balance the ship.

For all the official comments attempting to halt the rush, money markets still imply — give or take 10bps or so — about 150bps of easing from the Fed and ECB in 2024 and about 120bps from the BOE.

Bank of America’s final global fund manager survey of the year perhaps gave a better picture of the cresting waves.

Almost 90% of asset managers expect rates to be lower this time next year, 80% expect inflation will be lower and a record 62% see bond yields lower. And just as significantly, more funds saw global recession as the biggest tail risk to the year’s benign “soft landing” consensus than saw sticky inflation or hawkish central banks as a threat.

In less than two months, benchmark 10-year treasury yields have dropped 113bps, British gilt yields have dropped 112bps and German bund equivalents have lost 95bps.

And yet all three borrowing rates are only roughly where they were 12 months ago — and at least twice where they were 12 months before that.

There may be some way to go yet before high tide is reached and not a great deal that will stand in its way.

Reuters