COLUMN-An era of ‘forward misguidance’: Mike Dolan

(The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own.)

By Mike Dolan

LONDON, Nov 3 (Reuters) – Are markets challenging central banks – or is it the other way around?

There may be good reason for central banks to muddy the waters in a period of inflation uncertainty – not least to jar complacent investors from betting on cheap credit forever. But this could come with a hefty price tag.

Seismic moves in interest rate markets in recent weeks followed a mix of new signalling by major central banks that basically rendered unreliable their previous insistence on borrowing rates staying near zero for the next year or two.

So-called “forward guidance” has got murkier and it culminated last week in outright policy surprises.

Most obviously, the Bank of Canada abruptly abandoned bond buying and signalled a rise in interest rates early next year. Then, after days of an eerie “no show” on open markets, the Reserve Bank of Australia (RBA) formally ditched its yield curve target of 0.1% this week and swore it was unlikely to return.

Even though the RBA dissed speculation about policy rates rising next year, money markets continue to price in as many as three quarter-point hikes through 2022.

A month of hawkish Bank of England speeches, meantime, has stampeded money markets toward a possible UK rate rise as soon as this Thursday – and more than a full percentage point within 12 months. Such an early move had neither been warned of, nor bet on, as recently as August.

And what was seen as equivocal language from the European Central Bank last week has led to a hardening of money market pricing for a small hike in its deeply negative policy rate in 2022 despite overt ECB protestations.

In effect, markets are now ignoring explicit guidance from at least two of the world’s leading central banks.

This ups the ante for the U.S. Federal Reserve this week. The Fed is set announce an imminent tapering of its $120 billion a month bond-buying programme, but markets are already priced for at least two policy rate hikes next year, with Goldman Sachs forced late last week to abandon forecasts for no rate rise at all in 2022 and now match the two hikes embedded in the rates curve.

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“Central banks have lost – or are very close to losing – control over interest rates,” said Chris Iggo, chief investment officer, core investments at AXA Investment Managers.

“Now the inflation cat is peaking out of the bag, the incumbent framework for setting rate expectations is perhaps inadequate,” Iggo added. “It’s almost as if central banks want the market to do their work for them.”

GUIDING LIGHT

The idea that central banks might want markets to tighten up without necessarily going as far themselves is not fanciful.

Central banks didn’t always tell markets what they were going to do next. For years, an element of uncertainty was considered an important part of how markets functioned, long-term risk premia were considered healthy, and…