Analysis of today's markets

Álvaro Manteca, Director of Investment Strategy at BBVA Private Banking

The spotlight is now on the central banks

12/13/2021

The moment of truth is here. Between last week and next, no fewer than 18 central banks are deciding their monetary policies, influenced by a global context of uncertainty caused by the omicron variant and the persistence of significant inflationary pressures. Although there are obvious differences between different countries, the general trend continued to be to normalize the extraordinary monetary stimuli that were implemented in March 2020. The most relevant exceptions in this regard are still the central banks of China and Turkey.

This week will be very important in this regard, with meetings of the Fed, the ECB, the Bank of England and the Bank of Japan, all of which, except for the Bank of Japan meeting, could be quite relevant. First, the tone of Fed officials has become more aggressive in recent weeks due to continuing inflationary pressure, which again showed a significant increase in November. Thus, the FOMC is quite likely to announce an acceleration in its tapering, with asset purchases ending in March. Similarly, the updated dot plot, which reflects the rate expectations that the institution's members are working with, will move up the cycle of interest rate hikes, probably showing two increases in 2022, three in 2023 and four in 2024.

As for the Bank of England, the onset of omicron could delay the first rate increase since the onset of the pandemic until early 2022. The government has announced the return of some mobility restrictions, and the indicators of high-frequency activity have begun to taper off. In fact, the data show that the economy grew by barely 0.1% in October. Meanwhile, at the ECB meeting, we will keep a close eye on new macroeconomic forecasts. With regard to monetary policy measures, the governing board is likely to confirm the end of the PEPP program in March, with tapering that will start in January 2022. It will also reinforce the APP ordinary purchasing program with a significant additional provision. Finally, fewer surprises are expected at the meeting of the Bank of Japan, which will probably keep its current monetary policies unchanged.

Apart from the four large banks, other central banks in developed economies will announce their decisions. Although there is still some disparity, monetary authorities in commodities exporting countries are spearheading the movement toward monetary tightening. Last week, for example, the Bank of Canada announced the first rate hike in the first half of 2022, and the Bank of Australia stood by its forecast to raise interest rates for the first time in November 2022. This week, Norway's Norges Bank is expected to raise interest rates for the second time, after having done so for the first time in September.

As for the central banks in emerging countries, they are generally tightening their monetary policies quickly. In Europe, the National Bank of Poland hiked its rates by 50 basis points last week, while the National Bank of Hungary reported another increase in its weekly deposit rate of 20 basis points. In the coming days, the Central Bank of Russia is expected to raise its rates by another 100 basis points, to 8.50%. By contrast, the consensus expectation is for the Central Bank of Turkey to lower its rates by another 100 basis points, to 14.0%, despite the continuous deterioration in inflation rates and the severe weakness of the lira.

In Latam, Brazil's central bank raised its interest rate last week by 150 basis points, to 9.25%. Peru also raised its rates last week. Meanwhile, Banxico is expected to raise the benchmark rate by 25 basis points to 5.25%, while a greater increase is expected in Chile, up by 125 basis points to 4.0%.

In Asia, however, central banks are generally still more restrained than their emerging counterparts. This week, the central banks of Taiwan, the Philippines and Indonesia are expected to maintain their official interest rates unchanged, amid greater uncertainty around omicron and the desire to prop up the economic recovery. For its part, China's monetary policy is becoming more lax and the PBoC reduced the mandatory reserve ratio for banks, starting on December 15. The decision was made following a meeting that emphasized the need to increase support for the real economy, which is being dragged down by problems in the real estate sector.

On the health front, the threat of the omicron variant is starting to appear less ominous than initially feared. According to the most recent data, the variant has been detected in almost 60 countries. Although its transmission rate has been determined to be higher, the vaccines do seem to be at least somewhat effective and the severity of its symptoms could be lower. In South Africa, COVID-19 cases have increased rapidly, but hospitalization rates remain low compared to previous waves. Another positive development was the Pfizer/BioNTech report, which maintains that a third dose of its vaccine is capable of neutralizing the omicron variant. This news, combined with the rise in cases in several countries, will probably accelerate the worldwide vaccination campaigns and possibly also see the gradual implementation of COVID passports in an effort to increase vaccination rates.

In short, this week is providing a real trial by fire for the markets, given the intense activity involving the world's leading central banks. In this regard, the Federal Reserve meeting will be the highlight of the week.

Our intuition is that the Fed is on the right path with its new, more aggressive monetary policy, as it lets it reduce the risk of making a major mistake if the more structural nature of inflation ends up being confirmed. Although there are some elements that lead us to continue thinking that this inflation is temporary (higher levels of inventories and production, some standardization in supply chain stresses and lower prices of oil and other commodities), high inflationary pressures on the housing market and the omicron variant, which could lead to another wave of interruptions in the supply chain, mean the upward risk for inflation remains substantial. As a result, salaries and rental income could easily replace the tensions related to the economic reopening after the pandemic, and drive inflation in 2022.

The Fed is likely to believe that the economic growth forecast for 2022 can withstand somewhat stricter monetary conditions. Thus, a moderate increase in rates would ensure that inflation expectations remain firmly anchored, while avoiding the risk of remaining "behind the curve" and having to abruptly rectify monetary policy, which would seriously jeopardize the ongoing economic recovery.

However, the risks remain relevant and even though the first signs point to a more benign omicron variant, we cannot rule out transitory episodes of volatility, which might also reflect heightened geopolitical risks.

In any case, we continue to trust in the strength of the economic recovery, and we believe that the best strategy continues to be to remain overweight in risk assets.