No Consensus On The Direction Monetary Policy Should Take

Furthermore, it says there are many questions on whether recent bond market ructions in the UK are idiosyncratic or carry broader meaning for other countries.

No Consensus On The Direction Monetary Policy Should Take
Photo by Woldai Wagner / Unsplash

Regarding the pace of monetary tightening, analysts from the International Institute of Finance believes there is no consensus on whether to slow the pace of hikes, especially in the US.

As far as we can tell, what happens in the US on the fight against inflation and stagflation does not stay in the US, thus we must assume that this is the case - that is a lack of consensus and decision making, on global monetary tightening.

Given the economic turmoil developing in the UK that has been more or less the cause of the demise of the Liz Truss rule, this is cause for great concern for businesses altogether.

Nevertheless, let us see what the IIF has to say as it adds that in contrast, there is growing consensus that liquidity across different markets has deteriorated sharply and may worsen further into year-end.

Furthermore, it says there are many questions on whether recent bond market ructions in the UK are idiosyncratic or carry broader meaning for other countries.

Translated into simple english, we can say that the world's economy is heading for a recession and the signs that the prospect of a global recession is not going away but is deepening in view of the political instability in some countries and market turmoils across the continents.

"On the last theme, our view is that the UK is best seen in the context of the global COVID debt run-up and with large issuance needs for climate change and defense ahead. Fiscal space has shrunk globally, and the UK is far from unique in that respect. In fact, the UK debt-to-GDP ratio is significantly below that of other advanced economies," says the IIF.

The FEDs Monetary Policy

The Fed has now hiked a cumulative 300 bps this year, with three back-to-back 75 bps hikes in June, July and September.

Markets price continued hikes at this rapid pace in coming months. Surprisingly, given the mounting risk of global recession and US housing that is weakening sharply, there is little consensus on the path forward.

An equal number of market participants advocate continued rapid hikes versus a dovish pivot (Exhibit 1). 

An equal number of market participants advocate continued rapid hikes versus a dovish pivot (Exhibit 1).

The IIF says this is partly because inflation ran hotter than we and many others expected in recent months, although our work on inflation generalization continues to point to moderation in the combined weight of items with month-over-month inflation above 2 percent (Exhibit 2).

While there is no consensus on monetary policy, there is – across the board – mounting concern on market liquidity.

Widening cross-currency basis (Exhibit 3) Government bond markets (Exhibit 4) 

"There are initial signs that cross-currency basis is widening out (Exhibit 3), an indication that the usual end-of-year Dollar hoarding may be more acute this year. The same is true for government bond markets (Exhibit 4), where the Bloomberg index of liquidity points to deterioration across the board.

"One theory for this broad-based drop in liquidity is that this year’s unusual volatility in commodity markets has put market makers close to their risk limits, so that risk-taking has been cut across the board. Regardless of the underlying driver, liquidity is widely expected to deteriorate further as we approach year-end," it says.

UK Bond Market Chaos

Many are focused on the significance for other countries of recent UK bond market ructions.

the UK debt-to-GDP ratio and The rise in global R*

"We think the UK is best seen in the context of the global COVID debt run-up and with large issuance needs for climate change and defense ahead. Fiscal space has shrunk globally, and the UK is far from unique in that respect.

"In fact, the UK debt-to-GDP ratio is significantly below that of other advanced economies (Exhibit 5). This goes to something we have been warning about for well over a year.

"The rise in global R* makes it harder for some countries to access markets, necessitating help from central banks (Exhibit 6). The days of easy deficit financing are unfortunately over." says the Institute.