Wrong, wrong, wrong

Your esteemed blogger has plenty of experience of calling central bank actions incorrectly, but two in one day may represent an unwanted first. Neither the Bank of Canada nor the Fed delivered rate hikes today, so I got that wrong -- but so, in my considered opinion, did the Bank and the Fed. 

The Bank of Canada got the ball rolling this morning, keeping its overnight rate target unchanged at 0.25 percent. Given recent, more hawkish signals from the Bank, markets had placed about a 70 percent probability on a rate increase today. Indeed, the Bank's press release could have been used almost unchanged if it had in fact announced a rate hike, which may be an indication that this was a very close-run decision. In contrast, arguments against an early move are very thin on the ground. Consider: 

" In Canada, GDP growth in the second half of 2021 now looks to have been even stronger than expected. The economy entered 2022 with considerable momentum, and a broad set of measures are now indicating that economic slack is absorbed. With strong employment growth, the labour market has tightened significantly. Job vacancies are elevated, hiring intentions are strong, and wage gains are picking up. Elevated housing market activity continues to put upward pressure on house prices.

The Omicron variant is weighing on activity in the first quarter. While its economic impact will depend on how quickly this wave passes, it is expected to be less severe than previous waves.... After GDP growth of 4½ % in 2021, the Bank expects Canada’s economy to grow by 4% in 2022 and about 3½ % in 2023.

CPI inflation remains well above the target range and core measures of inflation have edged up since October. Persistent supply constraints are feeding through to a broader range of goods prices and, combined with higher food and energy prices, are expected to keep CPI inflation close to 5% in the first half of 2022.... Near-term inflation expectations have moved up, but longer-run expectations remain anchored on the 2% target."

Plenty of evidence to support a rate hike there, and the sentence immediately following that extract should have sealed the deal: "....Governing Council judges that overall slack in the economy is absorbed, thus satisfying the condition outlined in the Bank’s forward guidance on its policy interest rate."  Rate hikes are clearly imminent -- "Governing Council expects interest rates will need to increase" -- so, given the tone of the release and the fact that markets were primed for a move, the only real mystery is why the Bank did not choose to start the tightening cycle today. 

Down in DC, and facing even higher inflation than Canada's, Fed Chair Jerome Powell had sounded unmistakably hawkish in recent weeks. Back on January 11, Powell told the Senate Banking Committee that “If we have to raise interest rates more over time, we will .....We will use our tools to get inflation back.” Despite this, market expectations were not pointing to a rate hike at today's FOMC meeting. And indeed, the FOMC kept rates unchanged today, even as it issued a press release that, like the Bank of Canada's, could equally have been written to support a rate move:

"Indicators of economic activity and employment have continued to strengthen. The sectors most adversely affected by the pandemic have improved in recent months but are being affected by the recent sharp rise in COVID-19 cases. Job gains have been solid in recent months, and the unemployment rate has declined substantially. Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses. 

The path of the economy continues to depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain, including from new variants of the virus. 

....With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate."

Why the hesitancy, in both Washington and Ottawa?  The Fed can at least make the case that it has not yet finished tapering its QE program, though it expects to do so by the beginning of March; the Bank of Canada has already ended its program. Do geopolitical uncertainties, mainly regarding Ukraine, weigh heavier in central banks' calculus than soaring oil prices and the risk that rising inflation expectations will become embedded?  It seems unlikely.

Have both the Fed and the Bank been spooked by the gyrations in markets in recent days?  It is hard to separate out how much those gyrations may have been driven by geopolitical factors and how much represents a delayed "taper tantrum".  However, if both central banks were looking to avoid creating extra uncertainty, holding back on a rate move when one had been so clearly telegraphed is surely not the right way to do it. It simply prolongs the markets' anxiety until the next rate decision day. It says here that both the Fed and the Bank of Canada missed an opportunity today, something they may come to regret.