First, they have found themselves in a perilous game of chicken with international bond investors. Conceivably they should take heed of the former political adviser to President Bill Clinton, James Carville, who famously remarked: “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” Including, evidently, central bankers.
For much of this year investors have swallowed the mantra repeated by central banks that the current post-pandemic burst of inflation is merely transitory and that there was no need to raise interest rates. The dictum has been that all will, in due course, revert to mean as the current spike of inflation is fundamentally cost-push and supply side in nature, and that no amount of monetary tightening could affect it. Now, however, bond investors are starting to bet that, with energy prices spiking and supply chain bottlenecks showing no sign of abating, borrowing costs will continue rising.
The sell-off in the two-year Treasury is the clearest indicator of concerns that shortterm inflation is here to stay. Having hovered around 0.150% for much of the northern summer it has recently spiked up to around 0.5%. We are witnessing the immovable object of central bank easing and low rates meeting the unstoppable force of the weight of bond market bears. Something will have to give.
What’s more, their toolbox is all but empty. More than a decade of almost continual monetary easing has meant that the market has come to price in the kitchen sink of free money being thrown at the economy; anything less risks being catastrophically disappointing. The Bank of America estimates that, since the collapse of Lehman Brothers, around $23-trillion of financial securities have been bought by central banks.
However, should the inflationary pressures above prove to be more than transitory then we could be at the very end of this era of monetary largesse. The Bank of Canada last week was the first central bank in a developed country to hike rates, with the Bank of England and the Reserve Bank of Australia likely to follow suit shortly. The US Federal Reserve could also start trimming its monthly $120-billion purchases. Could we truly be seeing a new era for central bankers?
If so, traders have labelled this new central banking epoch one of TNT; first taper, and then because of inflation they will have to start tightening. Given the frothy valuations of equity markets, the effects of such a volte-face could be even more explosive than the name suggests. If this happens it will not be so much about burning down the house as putting a ton of nitroglycerine under the entire metropolis of financial markets. And with rates going up, nothing will be spared.
Finally, things are looking especially bleak for emerging market central bankers such as the governor of the South African Reserve Bank (Sarb), Lesetja Kganyago. In a post-local government election context, with all of its political uncertainties, he is faced with rapidly rising consumer prices, skyrocketing energy prices, stagnant aggregate demand, footloose international capital, angry and desperate consumers, and an anxious political class that is becoming increasingly wanton about giving cake to the masses.
Faced with a similar emerging market conundrum, Turkey’s President Recep Tayyip Erdoğan recently took it upon himself to fire his central bank governor and then instruct the new incumbent to cut rates in an effort to appease the chattering classes of Istanbul. The Turkish lira has duly collapsed in value, with inflation hitting around 20%.
South Africans would do well to take note of what is happening in Ankara. Economically, if Sarb does not tighten later this year, Governor Kganyago’s credibility will evaporate (as will in all likelihood the value of the rand and SA government bonds). However, raise rates too quickly and aggregate demand will collapse, sending the economy into a nosedive. It remains to be seen how long an embattled post-election ANC can cope with a hawk at Sarb.
Either way, he should perhaps start by brushing up his CV. Pity this generation of central bankers, but at the same time, may they be reminded of the verse: “Do not be deceived … for whatever a man sows, this he will also reap.” DM168
This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.