Dhara Ranasinghe & Sujata Ro

LONDON (Reuters] – December will present a major challenge for financial markets that have had a difficult year trying to understand central bank policy signals. This is because the Federal Reserve and Bank of England are holding crucial meetings within 24 hours.

They come after a year in which central banks generated frequent market turmoil. The most recent example being the BoE’s shocking “no change” decision on Nov. 5 and October’s cautious rate-hike pushback from the European Central Bank. Also, the failure of the Reserve Bank of Australia to protect its bond yield target.

So it’s not surprising then, that just a few days before 2021’s last crop of meetings, asset price volatility measures are climbing higher with currencies and bond vol gauges at their highest level in months.

The Fed’s December 15 1800 GMT statement could announce a faster tapering of asset purchases and reveal future rates.

Following its November rate-holding decision, the BoE met again on Tuesday to discuss market pricing.

The European Central Bank announced plans to buy two bonds in less than an hour; this could have serious implications for Italy and other countries with high levels of debt.

It is by nature of its business, Monetary Policy messaging can be a complex and inexact. The outcomes are difficult to predict due to unexpectedly high inflation, the supply-chain challenges to economic recovery, and COVID’s ongoing background threat.

Carl Tannenbaum stated that “whether it’s Madame Lagarde, Andrew Bailey, or Jay Powell the current circumstances create almost a perfect storm for challenge to central bank communications.” Northern Trust (NASDAQ) Chief economist of the Fed’s Risk section in 2008, during which the financial crisis hit.

He hopes that these meetings will result in a “much candider and more fulsome conversation”, especially regarding inflation and labour market issues.

Investors have expressed sympathy for the central bankers, whose task of navigating the communications tightrope was made more difficult by the market’s enormous clout. This is far beyond what previous central bankers were faced with.

The global equity market is worth close to $100 trillion. This figure almost doubles the pre-pandemic level. Government spending has boosted bond markets. The potential for major setbacks in trading at high valuations.

The signalling effect is felt far beyond the markets. British banks were so certain of a rate increase in November that they moved their home loans costs up before the BoE meeting.

The message central banks need to send is simple: they will support the economy in the short-term and ensure price stability long-term. However, in high-stakes markets where sentiment is volatile, it can be more challenging than it seems.

The change may cause a reconsideration of signalling strategies. Bailey from the BOE suggested, for example, that we return to a non-guidance position.

Richard Barwell (OTC:) Asset Management is a former BoE economist and heads macro research at BNP Paribas. He says that central banks want to keep the option of tightening policy but not commit to it.

“The challenge is to make the necessary change – and create that option – without destabilising markets by convincing them that the option is certain to be exercised,” he said. 

UNRELIABLE BOYFRIENDS

Barwell stated that any bank considering December policy tightening should explain its decision to the Omicron COVID variant. The risk is that markets will price out rate increases in the future.

This is a particular problem for BoE Governor Bailey. According to Barwell, Bailey has a “Grand Old Duke of York” problem. It refers to an English nursery rhyme that describes a futile act.

He added that “There might be a limit on the number of times the policymakers can marche the market up the hill of rate hikes only to have it go back down.”

Bailey was quickly dubbed “Unreliable Boyfriend Number 2” by the UK media. 2. This is an update to the moniker that was given to Mark Carney’s predecessor, who sometimes didn’t translate his policy signals into actions.

Christine Lagarde, chief of the ECB was also criticised after she rejected rate hikes for 2022 priced in October. This boosted bonds and helped boost euro. The moves were reversed by Lagarde, who resisted rate increases forcefully the next week.

Jerome Powell of the Fed seems to have won top marks for not only his openness to admitting he did not have all the answers but also because of how he handled it. However, his calm has been shaken recently. After telling legislators Omicron might jeopardize economic recovery, Powell suggested that it was time to end considering inflation transitory.

After a period of weakness, the dollar shot up straight again.

But Timothy Graf, State Street (NYSE:). Powell, the EMEA’s chief of macro strategy for EMEA, praised Powell because of his honesty and openness. This parallels the candour of Mario Draghi ex-ECB chief, who is credited with saving the euro area from the 2011-2012 crisis.

Graf explained that “the Fed is correcting what was perceived earlier this year, wrongly or rightly, as having had a slightly relaxed approach towards the inflation question.”