Oh dear, central bankers have outdone themselves in the last fortnight.

It’s getting clearer with each passing day that they’re not used to dealing with (nor have tailored tools to fight) supply-side inflation.

That is, inflation caused by shocks to the supply-side (cost-push) as opposed to the sort of inflation caused by increasing demand/increasing growth and accommodative monetary policy.

And we’re unlikely to see demand-pull inflation for awhile as most economies have been disinflating for over a decade (but for COVID supply side inflation).

Many say we are staring at a supply-side camouflaged stagflation.

When you think about it, robotics, Ai, blockchain, e-commerce, advanced manufacturing, crypto and the list goes on, are all disinflationary.

Other than for supply shocks to oil, materials, consumer durables and even stock for retailers, the world is dis-inflating because technology is eating up the old economy and demographics are lopsided.

That will play out, but let’s see what perhaps ‘non-permanent’ supply-side inflation in light of the long term disinflationary trend (and global indebtedness) has caused central bankers to think and do, of late.

The U.S.

It’s led to Fed Chair Powell starting a taper that’s not really a taper because he feels supply side-inflation is transitory, or non-permanent. And rates went up. More on that in Powell’s Pantry in the final section.

Australia

An inability to defend against supply-side cost pressures touted by inflation front-runners led RBA Governor Lowe to abandon YCC (yield curve control) and stand out of the market just prior to telling everyone what he had done.

And the two year jumped by over 0.5% before settling back after guidance was later provided at the RBA’s 2 November meeting. This goes to show how effective guidance (proven by the lack thereof) is as a monetary policy tool. It’s a verbal/virtual lever.

Here are the detailed notes from the RBA’s 2 November meeting, released yesterday that seem to smooth over the keystone cop looking activities of the Gov:

“Members discussed the Bank's decision to stand out of the market in the days between the CPI release and the meeting. This had resulted in uncertainty about the Bank's policy intentions and had affected market pricing and liquidity for a period. Members acknowledged that the Bank had faced the difficult choice of entering a thin market in an effort to defend a target that was losing credibility or standing out of the market until the Board had an opportunity to consider the implications for monetary policy of the most recent data and the updated forecasts. Members acknowledged the Governor's authority to exercise discretion in implementing the Board's policy decisions. In that regard, the Board supported the Governor's decision to exercise discretion in these circumstances.

But, like Powell, the RBA caveated Lowe’s discretionary move with the following :

“Members saw merit in reviewing the operation of the yield target and its effectiveness as part of the broader package of monetary policy measures introduced in March 2020. This would be done in 2022 and in light of additional information on the effect of the overall policy package on the Bank's goals.”

In other words, if in due course we need it again (or other exigent tools) we will pivot.

Uncharted waters in Australia as well - but what’s really behind this is an acknowledgement that we cannot do anything in isolation from the U.S., and given Powell’s clayton’s taper, Governor Lowe needs some wriggle room as well.

UK

Cost push inflation and its ripple effects (which are continuing and hit 4.2% in October, as released just now) also resulted in the Bank of England telling the market it would raise interest rates, watching that being priced in, and then doing nothing for fear of defaults. WT? And rates went down.

Guidance countermanded? About face?

No further comment here given I think it was a joke. And as former Prime Minister Keating said to the Melbourne Press Club last week, it’s enough to make a cat laugh.

What it all means

UK talks up rates, does nothing, rates go down. Australia ditches high volume YCC, rates go up and then fall with reassuring guidance. U.S. puts on a claytons taper, rates go sideways.

What does it mean for you and me?

It differs, because the size of the supply-side inflation tax (weighed against other in-country benefits and detriments) depends on where you live and whether you are a saver or borrower, and/or in or out of hard assets.

What do these differing moves mean for central bankers?

Well, as I’ve been writing since the aftermath of the GFC, increasing interest rates in a badly indebted world is going to be extremely difficult, if at all possible, and while central bankers should and will try to do it they will probably fail or have to reverse it again to cool down the risk of debt defaults.

Unless they do it very slowly the cure will be worse than the cause, as the Fed of 1928/9 and the Volcker and Greenspan Fed’s found out.

One thing is clear though, and that is that none of these central bankers want to verbalise that if you combine zero bound interest rates in a seriously indebted world that is the subject of pandemic shutdowns and inability to supply into demand (because the Fiscal broke decades ago and the population is ageing), you need a new play book - and Amazon doesn’t sell it.

It also means that all eyes again are on the reserve currency, i.e., the US dollar, and on whether Powell remains and continues down his claytons taper path, or whether Brainard or someone else is appointed.

Other countries are likely to hold fire and like it or not, will be drawn into a policy that may differ a little, but overall will need to be consistent with the U.S path - and the Fed is painted into a corner at the zero bound.

So what is that recently came out of Powell’s pantry (or did it, really)?

Powell’s Pantry - a taper designed to be ‘adaptive’ and to avoid a tantrum has led to a claytons taper

Below are some of the highlights I noted from Chair Powell’s Q&A with journos and analysts after his recent claytons taper announcement.

While consultative, he is definitely becoming more defensive and opaque, possibly because he’s up for re-election, or maybe because like other central bankers he is trying to sail in waters where the rest of the market has bought into permanent inflation (rightly or wrongly) and is frontrunning the Fed in the bond market.

To start, a taper is meant to remove liquidity/rocket fuel from secondary markets. It’s a slowing in a central bank’s buying of notes, bonds and securities and is aimed at syphoning off liquidity and generally cooling things down.

Think of a lazy Sunday where you get short black, croissant and then have a snooze. That’s a taper.

But in this case, Chair Powell called for a panic baguette with a two month ‘suck and see’ on the side, just in case.

That means it cannot be put on auto-pilot, and for Powell it removes any embarrassment if it’s the wrong move and he has to reverse it, and go back to the old levels of bond/mortgage backed securities purchases.

As I’ve suggested for some time now, any taper, if there is one, is unlikely to be meaningful or persistent. But, I hope I am wrong.

And thus, we have a non-alcoholic, non-carbonated experiment that’s coloured and packaged to resemble a taper.

At the same time as the announcement, he said there is no intention to raise interest rates until the economy gets back to full employment.

In other words and unlike Governor Lowe here in the land of iron Oz, he sees inflation as non-permanent. And without full employment to contend with, he is not prepared to even engage in discourse on the interest rate lift-off.

But the U.S. bond market disagrees and feels the Fed will be pulled into rate hikes as early as mid-next year. That’s why the US market seems to be front running the Fed by demanding higher bond yields now to reward for inflation that the Fed says is still transitory, but which the bond market feels is permanent in some items.

For equities, the claytons taper is confirmation that it’s not a bad or big or permanent taper with no rate hikes until 4.2 million Americans which need jobs to get back to pre-pandemic levels, i.e., actually re-join the workforce.

But this is probably a good thing given any serious taper in light of the indebtedness foreshadowed will need to be reversed.

One question mark over this is the effect of COVID, Ai, automation, robotics and software and whether the 4.2 million will return.

For companies, it means still cheap borrowing, expanding price earnings multiples (also relevant for investment portfolio allocation) and a focus on M&A as companies impacted by supply chain blockages run for cover.

For the winners, it means taking their balance sheet and zero cost debt for a spin to gobble up competitors or diversify into web 3.0 and industry 4.0 opportunities, which for some may support reaching net zero by 2030.

For others, the plan is green washing to recapture the hearts and minds of disillusioned stakeholders.

And for many households, supply-side inflation is a big and bad tax unless they are in risk assets.

Here are some notes from Powell’s press conference (what he said) so you can see the language and the way he is hedging his bets - also noting he is shortly up for re-election (underscores added by yours truly).

Inflation has come in higher than expected and it is now expected to persist into next year, which was also unexpected.
Bottlenecks and shortages means the Philips Curve is irrelevant and that we have to be humble about what we know about this economy as a result of COVID.
The Fed has decided to ‘pause’ the pace of asset purchases, but there is no change to rates because there’s still ground to cover to get to maximum employment and there’s ‘still’ good reason to think the economy will reopen (past significant outbreaks of COVID) and that things will work out and that we end up back at maximum employment- and therefore our policy will need to remain adaptive.
On inflation there have been sizeable price increases in some sectors as a result of blockages/supply constraints and pandemic dislocations (which have been larger and longer lasting than expected). While the Fed knows the difficulties to sections of the community that high inflation causes it does have tools to ease supply constraints and believes the economy will adjust to demand and supply.
If the Fed sees material and persistent moves (in inflation) it will use immediate tools to control it.
Feels the Fed has now met the Taper test and late Nov reduce pace by $10bn for treasuries and $5bn for MBS plus same one in December. If economy develops as expected it will then do similar each month thereafter and therefore cease new purchase by the middle of next year, although the Fed will be prepared to change if there is a change in the economic outlook.
If the balance sheet stops expanding, he confirmed holdings of securities will continue to support accommodative financial conditions.
No change to rates for quite some time given the more stringent ‘test’ of maximum employment + consistent targeted inflation rate trigger to lift off the fed funds rate.
The level of employment (that makes up maximum employment) was not defined as the 4.2 million below pre-pandemic levels re-joining the workforce, but whatever the number is it will need to be consistent with the Fed’s price stability mandate.
Clarification that the Fed feels that “If something is transitory, it will not leave behind it permanently or very persistently, higher inflation.”
Powell was not ready to talk about a balance sheet run-off, i.e., the reinvestment of funds from maturing bonds. The Fed will set up a series of talks about this, starting now.
Confirmed the Fed does not know the effect of asset purchases on the economy when you’re at the zero bound. And with that, finally some truth.

More debt fuelled truths to face up to next month? More backflips?

Mike.

Size of supply-side inflation tax, depends on where you live

What it all means

Powell’s Pantry - a taper designed to be ‘adaptive’ and to avoid a tantrum has led to a claytons taper