Fixed income Fixed income What next for central bank policy? Will central banks stick to their goal of raising rates until inflation is back under control or will rising debt servicing costs make tolerance of inflation a more attractive choice? What does this mean for fixed income investors? Author: Fixed income team e are in an unusual situation: central or accept devaluation (effectively accepting inflation running scale but arguably with very little effect. Despite deploying Chart 4: Central Bank policy rates vs forecast peak banks are tightening monetary policy at higher levels than they target, for longer). zero or negative policy rates in many countries and creating to curb record levels of inflation, not trillion-dollar balance sheets, central banks found it was 5 when economic growth is strong, but as Central banks, keen to reestablish their inflation-fighting extremely difficult to bring inflation back to target. 4 Weconomies are already slowing dramatically credentials, will be determined and keep going down the ) and some are heading for recession (Charts 1&2). What does deflation route, deploying hawkish rhetoric along with big With central banks raising rates in the face of record 3 this mean? Will the fixed income strategies deployed over the rate hikes. But as recession looms, that may become a tough levels of inflation (Chart 3&4), it would be unwise to last 10 years work again? line to stick to. underestimate how much might be needed to bring licy Rate (%2 inflation back to target. Cyclical factors will probably help Po Central banks in many areas, including the US, Eurozone Controlling inflation stem the tide of inflation in coming months, but structural 1 and the UK, are likely to face a very stark choice as 2023 In trying to turn around economies for over a decade, central factors will also play a part and these could turn out to be progresses: either keeping to a path of deflation (effectively banks aimed for inflation that was close to or below target. A much more sticky. 0 Fed BoE ECB tipping their economies into recession to help tackle inflation), wide range of policy tools were brought to bear, at enormous Current Market-implied Peak Source: US Federal Reserve, Bank of England, European Central Bank, Chart 1: Real rates of GDP growth flatlining in developed markets Chart 2: Inflation in the US, UK and Eurozone see strong acceleration Chart 3 : US core PCE inflation breaches 5% as at 1 November 2022 % % % 40 12 6 35 The changing approach to policy 30 10 5 Central bank policy making has always been subject to 25 8 20 4 change over time. The last Federal Reserve (Fed) rate hiking 15 6 cycle, which really began in 2016, was overseen by Janet 10 3 5 4 Yellen. Policymaking was forward-looking, preemptive 0 and generally model-based. Rates were raised well before -5 2 2 inflation got back to target. And, in fact, it only just got -10 0 -15 1 above target in that period. -20 -2 -25 0 -30 -4 Dec-18 June-19 Dec-19 June-20 Dec-20 June-21 Dec-21 June-22 Oct-02 Oct-06 Oct-10 Oct-14 Oct-18 Oct-22 2010 2012 2014 2016 2018 2020 2022 US UK Eurozone US UK Eurozone Source: US GDP: US Department of Commerce; UK GDP: Office for National Source: US Department of Commerce; UK Office for National Statistics; Eurostat. Source: US Department of Commerce, Bureau of Economic Analysis, Statistics; Eurozone GDP: Eurostat. Data as at 30 June 2022 Data as at 31 October 2022 as at 1 November 2022 16 17