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Signal Versus Noise for Central Banks

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Major central banks around the world made some important announcements over the last two weeks. We believe these announcements give us some clear signals as to the course of the economy and markets—yet most were drowned out by the noise of technology earnings, trade wars and the all-consuming political news cycle. We have to admit, listening to Elon Musk can be far more amusing than listening in on the Bank of Japan.

The important signal is that central banks are generally moving from easing to tightening as economies recover and inflation moves closer to targets. As we know, less central bank accommodation usually leads to slower growth and can make the markets for risky assets go wonky.

Related: Central Banks Are Draining the Pool!

Last week the Federal Reserve justified its tightening stance by using the word strong four times in regards to economic conditions: “Economic activity has been rising at a strong rate…job gains have been strong…household spending and business fixed investment have grown strongly…supporting strong labor market conditions.”  It is no surprise we, and the rest of the developed world, expect the Fed to raise rates at its September meeting and to keep on raising rates thereafter.

Two weeks ago the European Central Bank (ECB) reiterated the message it intends to scale down its quantitative easing in September and then halt by year end. We even expect the ECB to think about raising rates. Maybe not at the moment, but the long-term direction is clear.

In other central bank news, the Bank of England (BOE) raised rates last Thursday to their highest levels in nearly a decade. The BOE is attempting to both hold down inflation and prepare for a potential economic downturn as Britain exits the European Union. It is easier to cut rates and support a weakening economy if rates are already well above zero.

The one standout in all this easing is the Bank of Japan, which still has made no indication it will increase rates. The interest rate on its 10-year bond is now less than 15 bps.

Although the signals for economic tightening are clear, the timing remains buried in noise.

Sources: The Federal Reserve, the Financial Times, the Wall Street Journal, Bloomberg
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