Arm wrestling with the central banks

"For the first time, market expectations reveal breaks in the forward guidance, the communication strategy on which central banks rely so much."

The arm wrestling between the financial markets and the central banks goes into the next round. So far, everything has revolved around the question of how the global surge in inflation should be interpreted. The market is now betting quite openly that the central banks are wrong: They are underestimating the inflation problem and have to raise key interest rates earlier than they announce. The money market rates, which reflect the central bank interest rates, then moved upwards. In the US, up to three rate hikes are anticipated next year, the first in June. In New Zealand, the key rate is even expected to rise by 2 percentage points.

Even in the euro area, a first rate hike in 2022 is priced in as possible (50% probability). On Thursday, ECB boss Christine Lagarde turned directly against this speculation. It contradicts the outlook of the ECB. Interest rates would be kept low for a long time to come.

This week it will be Fed Chairman Jerome Powell's turn. He faces an even bigger problem than his counterpart in Frankfurt. The Fed has always taken the view that policy rates will not be raised until after securities purchases have been scaled back. Now it must first decide when the dismantling will begin and at what speed it will be implemented.

Current market expectations are exaggerated. For the central banks, however, they pose a double risk. For the first time, they reveal breaks in forward guidance, the communication strategy that central banks rely on so much. They are less and less able to shape market opinion. If they do not regain the upper hand over the interest rate outlook, then the second pillar of monetary policy threatens to break away: the stable low inflation expectations of the public.