The central bank bonanza definitely kicked off with a bang today. While markets have been talking about the Fed all week, the RBNZ offered traders a bit of a reality check earlier today to not take anything for granted. Even with traders pricing in a roughly 90% chance of a 25 bps rate hike, the central bank instead held rates at 2.75% in a close 4-3 vote.
The surprise in terms of market reaction is captured by the kiwi, with NZD/USD down 1.3% to 0.5605 today. But is there a broader lesson that goes beyond what we have seen so far?
For the better part of the last decade, traders have grown accustomed to central banks offering plenty of forward guidance and holding their hands through major policy decisions. Central bankers would more or less signal their next move well in advance, giving traders a relatively clear path to follow in the lead up to the upcoming meeting.
Now, that kind of luxury appears to be slowly disappearing.
The fact of the matter is that central banks are having to deal with a very difficult balancing act at the moment. Inflation pressures remain stubborn and higher borrowing costs as well as mounting fiscal pressures are taking a toll on growth conditions, making it tough for central banks to commit to a particular policy path.
In looking at the RBNZ today, policymakers weren’t convinced that another rate hike was necessary just yet even with inflation running at 3.7% and projected to rise to 4.4% in the final quarter of the year. That’s a damning assessment of the current landscape that major central banks are dealing with.
While inflation remains the core problem that needs to be addressed, the risks to growth and the need to assess earlier tightening moves were enough to tip the balance towards waiting in the case of the RBNZ.
So, does that mean we should expect similar surprises from the likes of the Fed or ECB this week?
Well, not necessarily I would say. All else being equal, I would not overreact to one decision from a major central bank. After all, the RBNZ has had a knack for a few surprises every now and again.
For the Fed, they are widely expected to leave interest rates unchanged today. Meanwhile, the ECB is very much expected to stay on the sidelines tomorrow. Those remain fairly reasonable base case scenarios for the respective central banks.
In my view, the RBNZ surprise is less about predicting the next central bank shock and more about how markets should approach policy expectations from here.
Now, the Fed has to weigh persistent inflation against the risk of tighter financial conditions. As for the ECB, they must also contend with rising borrowing costs and fiscal concerns across Europe.
While the decisions this week are likely to play out according to market expectations, what happens after that is still up for interpretation. As it stands, no central banks want to commit to a rate hike today only to discover that growth conditions have deteriorated sharply a few weeks later.
Come what may, the Fed and ECB are two big names that typically do not try to upset markets and cause unnecessary volatility – especially at a time like this when borrowing costs are surging and inflation risks are mounting. If there’s an issue with the market pricing relative to their communique, policymakers would usually voice that out in the weeks running up to the next meeting. But then again, never say never when it comes to markets. That is a lesson every trader will learn at some point.
For the time being, we should still expect the next run out in the central bank bonanza to stick to the script even after the RBNZ surprise. However, whether or not policymakers will validate or invalidate pricing for upcoming decisions in the months ahead will be a separate issue.
But in seeing how things play out with the RBNZ, it is best to be reminded of the fact that a 90% probability is still at the end of the day just a market expectation. It is not a promise from policymakers to take action.
And in a time when central banks are progressively favouring flexibility over firm commitments, traders may have to get comfortable with a little more uncertainty when positioning for the months ahead.
This article was written by Justin Low at investinglive.com.