An era of conviction in the realm of monetary policy is being retired. The galvanising clarity of purpose that defined the past few years – epic easing followed by speedy tightening – is giving way to a phase likely to be characterised by ambiguity. It will be no less consequential for its more genteel pace. Do we have the stomach for it?
The global interest-rate cycle is close to a peak, but hasn't necessarily reached it. The case for rate cuts is built on the prospect of recession and a credit crunch. Inflation remains too high, however, and despite chatter about a downturn, labor markets show robust growth; hiring and wages unexpectedly picked in the US last month. Central banks may still pull the odd surprise hike, especially if they think they aren't being taken seriously when they rule out a pivot to easier money. Investors were unprepared for quarter-point hikes in Australia and Malaysia last week. Policymakers in both countries were assumed to have been done.
Decisions on whether to lift borrowing costs and by how much will become closer. Dissent among policymakers, rare of late, is likely to stage a comeback. Deliberations on how to describe the trajectory of rates – even if they haven't budged – may be more freighted. When the Bank of Japan recently dispelled the idea that rates could go further into negative territory, it was initially greeted as a sign tightening had moved onto the agenda. That was dismissed by new governor Kazuo Ueda, who sounded pretty dovish in the press conference hours later.
This gray zone has its own language, and for those who love precision it will take some getting used to. When asked on May 3 how much data the Federal Reserve will need to have before being comfortable that policy is tight enough to bring inflation down, Chair Jerome Powell said: "I think you're going to want to see that – you know, that a few months of data will persuade you that you've got this right kind of thing." A day later, European Central Bank President Christine Lagarde was pressed on what level of rates is sufficiently restrictive. Her response: "We will know what that is when we get there." In other words, trust me.
This sort of discretion and reliance on instinct harks back to the Alan Greenspan epoch at the Fed, particularly the mid-1990s. It's instructive because through 1994 and into the following year, America's central bank tightened rapidly before pausing and then didn't do a great deal for several years. The Fed responded to a slowdown in 1995 with three modest reductions. Then followed a stretch of glorious inaction, save for a hike of 25 basis points in early 1997, that only ended with Russia's default the following year. In his 2022 book, A Monetary and Fiscal History of the United States, 1961-2021, former Fed vice chair Alan Blinder, described it as a time of "fine tuning."
Reserve Bank of Australia Governor Philip Lowe didn't exactly use those words when the RBA shocked traders with a quarter-point climb in the benchmark rate on May 2, just one month after pausing. The dynamic Lowe sketched when explaining the decision at a business dinner in Perth wasn't far off:
If you read the Minutes from the previous meeting, that decision last time was finely balanced and the Minutes of that meeting set out the arguments to pause and to increase rates again. We considered the same set of arguments again today and the balance tipped the other way; and it tipped the other way because, over the past month, we saw further evidence of the strength of the labor market, the persistence of global inflation and the persistence of services pricing inflation here...So both last month and this month the decisions were finely balanced, but given the flow of data, we came to a strong consensus that it was time to move again today.
Rate cuts might not come soon enough for those betting on them. Policymakers don't want to go wobbly on inflation having proved their mettle the past 18 months. Nor do they want to kill growth.
When economists and traders began warning of a recession last year, the rumblings were predicated on the time-honoured notion that expansions don't just die of old age but tend to get smothered by central banks. Now, there are fears that the tumult in American regional banking will constrain credit enough to tip the US and, by extension, the world into contraction. That may hasten the pause, and extend its life.
The cuts part gets trickier. Guess we'll know it when we see it.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.