They have expressed puzzlement. They have called it a conundrum. Their analysis has implied that it would be temporary. Yet global bond yields remain very low, given the circumstances.
At the heart of the matter is a presumption that when central banks raise interest rates as the U.S. Federal Reserve has done eight meetings in a row all other interest rates are supposed to rise. That way, no matter what interest rate a company or a household is paying, they pay more, thereby slowing economic growth and reducing inflationary pressures. This time, it just is not happening has monetary policy become powerless?
In fact, monetary policy is becoming more potent, not less. The real conundrum is that the more potent monetary policy becomes, the less potent it will appear. Central banks have proclaimed that they will keep inflation low. The more their actions succeed in doing so, the more difficult it is to explain why they must take any actions at all. Perfectly timed monetary policy is pre-emptive, not reactive. It is like a driving a car with the cruise control engaged; the throttle moves up and down automatically, keeping the car’s speed constant, so anyone looking only at the speedometer might wonder why the throttle was adjusting. But a more aware driver knows that there are hills on the road and the cruise control must adapt to them.
As for financial markets, the more they see the cruise control successfully in action, the less they think about inflation. There is no inflation to speak of in the world today. Globalisation is harnessing low-cost labour around the world, reducing the cost of everything. High oil prices are not being passed on as higher inflation instead, higher oil prices are draining purchasing power from other sectors of the economy and reinforcing the deflationary bias that is already present.
In this context, rising short-term interest rates are already erasing that first tingle of inflationary fear that usually emerges when economic growth is very strong. Economic growth is moderating, world-wide, and long-term interest rates are falling, not rising. And, because the policy action is centred in the U.S., the U.S. dollar is strengthening, putting another brake on U.S. growth.
The story might have been different if all economies needed higher interest rates at the same time. Financial markets might then require more convincing that global inflation risks were under control, and long-term rates might rise temporarily as short-term rates were being jacked up. Exchange rates would play almost no role, in that case, because interest rate hikes would be synchronised across countries. But with the U.S. doing the tightening, exchange rates are playing a key role, as a higher dollar means that the U.S. economy imports lower inflation from abroad.
The bottom line? Monetary policy should be judged not on the mystery of its actions, but on the quality of its outcomes. Financial markets are telling us that central bank credibility is at an all-time high. With global economic growth likely to moderate further over the next 12 months, expect bond yields to remain low, and perhaps move even lower.
Stephen Poloz is Senior Vice-President and Chief Economist , Export Development Canada. His column appears weekly on www.ctl.ca