Twilight of the gods
Eight days that shook the markets
Investors wake up to the fact that conquering inflation will be painful
I do not expect moves of this size to be common,” said Jerome Powell, chairman of the Federal Reserve, on June 15th. The central bank had just raised its benchmark interest rate by 75 basis points (0.75 percentage points) to 1.5%-1.75%. It was the third increase in as many meetings and the biggest jump in short-term rates since 1994. The move was both expected and surprising. Mr Powell had warmed up markets weeks ago to the prospect of a 50-basis-point increase at this monetary-policy meeting. But in the days leading up to it, investors had quickly and fully priced in a larger rise—with more to come.
Mr Powell’s comment about uncommonly large increases was enough to spark a partial reversal of the sharp rise in bond yields over the preceding days and a relief rally in share prices. But however much he tried to sugar-coat the message, rates are going up by a lot more and the chances of a hard landing for the economy have surely increased as a consequence. Recession is now more widely expected, if not (yet) by the Fed. And the rapid changes in the market mood show just how much the Fed and other rich-world central banks have lost control of events.
The Fed’s interest-rate decision came at the end of an extraordinary few days in financial markets, in which bond yields shot up at a violent rate, share prices plunged and riskier assets, notably bitcoin but also Italian government bonds, were trashed. The story begins not in Washington or New York but in Sydney where, on June 7th, the Reserve Bank of Australia raised its benchmark interest rate by 50 basis points, citing growing worries about inflation. It continued in Amsterdam, where in the following days the European Central Bank (ECB) held its monetary-policy meeting, in a break from its usual setting in Frankfurt. Christine Lagarde, the central bank’s boss, confirmed that a 25-basis-point rate increase would be on the cards in July. But she went much further. The ECB, she said, expects to raise interest rates perhaps by 50 basis points in September and anticipates "sustained” increases thereafter. The catalyst for this more hawkish stance was a sharp upward revision in the central bank’s forecasts for inflation.
This set the stage for a dramatic shift in bond markets, which events elsewhere added impetus to. The yield on ten-year German government bonds, known as bunds, rose quickly to above 1.75% over the following days. The yield on riskier sorts of euro-zone government bonds, notably Italian BTPS, rose by even more. The spread (excess yield) on BTPS over bunds widened sharply, taking Italy’s ten-year yield above 4%. Indeed spreads had risen so swiftly that the ECB’s rate-setting council held an emergency meeting on June 15th to address the matter (see next story).
But it was news from America that really moved markets. Figures released on Friday June 10th showed that annual consumer-price inflation rose to 8.6% in May, the highest rate since 1981. Underlying price ("core”) pressures were unexpectedly strong. To make matters worse, a survey by the University of Michigan showed that consumers’ expectations of medium-term inflation had risen markedly. Taken together, the reports suggested that inflation would be much harder to bring down.
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