Macro matters

Macro matters: The great global policy divergence

Stay up to date on the latest moves from major central banks across the world.

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August 1, 2023 | 7 minute read

Macro Matters connects the economy to markets, and often there is no stronger point of contact than monetary policy. The story in the U.S. is well mapped—40-year high inflation drove the Fed to the most aggressive rate hike cycle since the 1980s. But now more than ever, the global policy trajectory bears close watching. Most developed central banks have broken a 15-year streak of keeping rates at or near zero, sparking extraordinary moves in currencies, interest rates and equities. Looking ahead, rate hike cycles may increasingly diverge, with broad-based implications for regional business cycles. Because we think global monetary policy could be one of the most dominant forces to impact markets in the next several years, we have built the Global Central Bank (GCB) Guide that can be a single source to check these vital trends. This Macro Matters isn’t just a Federal Open Market Committee (FOMC) postmortem. It’s an introduction to a critical tool for global investors: Our GCB Guide breaks down what global central banks have done, where markets expect them to go and frames it against the macro backdrop of each country or region.

Simultaneous global tightening on an unprecedented scale

Source: Federal Reserve, Bank of Japan, European Central Bank, Bank of Canada, Bank of England, Reserve Bank of Australia, as of July 28, 2023.

Fed hits play following a pause: The Fed took rates 25bps higher to 5.25%–5.50% on Wednesday, July 26, as expected, following the pause in June that punctuated 10 straight rate hikes over 15 months. The Fed funds rate stands at a 22-year high, after 525bps worth of hikes since March 2022—the most aggressive rate hike cycle since the 1980s. The FOMC statement from July was practically verbatim compared to the statement from June, with little forward guidance and an emphasis on upcoming data. At the press conference following the meeting, Fed Chair Powell acknowledged the progress made on the inflation front but maintained a hawkish bias. He noted that while the impact of this historic tightening campaign has seen success, with headline Consumer Price Index (CPI) in June dropping to 3.0% y/y, far below the 9% peak last summer—the committee is holding out for signs of further softening across a variety of leading inflation indicators, most notably wages. The current Fed dot plot shows the terminal rate reaching 5.6% this year, implying one more 25bps increase by year-end but with nearly two months’ worth of data to be released between now and the Fed’s next meeting on September 20—additional steps remain uncertain.

Next Fed meeting too early to call: Markets seem convinced that the July rate hike was the Fed’s last, despite Fed Chair Powell clearly leaving options open on the topic of a pause. As of now, the likelihood of a September hike is priced in at only 22% but the foundation for this outlook is shaky. Recent data and market performance show a strong economy that could fuel further inflation down the line. The economy expanded 2.4% in Q2, an acceleration from 2.0% in Q1, and faster than consensus. Meanwhile, the Consumer Confidence Index hit a two-year high in July and initial jobless claims plummeted to a five-month low. In bond markets, yield curve inversion is a historic warning sign of recession. But in other markets, pricing would imply no concern about a downturn whatsoever. High yield bond spreads have tightened nearly 80bps since May and the S&P 500 is up 20% year to date. Keep in mind that prior to SVB’s collapse, the market implied terminal rate was in line with the Fed’s current guidance at 5.65%. Now, as regional bank fears recede in the rearview mirror, the Fed may see room to tighten further. Markets have been caught wrong-footed throughout this rate hike cycle by underestimating the Fed’s resolve to raise rates. With two CPI prints and two payroll reports between now and September, much remains in the air: Markets should remain cautious.

Europe and the U.K. still playing catch-up. In the U.K. and Europe, central bank officials remain in tightening mode. While the Euro area disinflation process appears to be following the U.S., it’s on a six to seven month delay due to the energy shock related to the Russo-Ukrainian War. The European Central Bank (ECB) took rates 25bps higher in July, as widely expected, hitting a post-2000 high, but appear to be closing in on the end of their tightening cycle. President Lagarde struck a relatively dovish tone in her statement following the July meeting, emphasizing the need to “keep an open mind” in terms of policy directive moving forward; thereby opening the door to a possible pause in September. Similar to the Fed, next steps for the ECB remain murky. Markets are pricing in a 40% chance for one more hike in September and a 75% chance of at least one more hike by year-end.

The Bank of England (BOE) is the furthest from the finish line, as policy makers continue to battle elevated inflation against the country’s improving growth outlook. Prior to June, the U.K. had seen four consecutive CPI prints surprising to the upside, with core inflation in May hitting the highest level in over 30 years. Though inflation fell in June, the U.K. still has the highest inflation in the G7. Markets expect the BOE to hike rates another 75bps across the next three meetings.  

After nearly a year and a half of vigorous rate hikes, markets expect that most major central banks have reached or are approaching the end of their tightening cycles, with the BOE being the clear outlier. Banks are pricing in a period of sustained pause is priced in over the next year with the expectation being that policy makers will make broad-based rate cuts a year from now.

Markets widely expect that policy rates are near their peaks

Source: Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Bank of Korea, Bloomberg Finance, L.P., as of July 28, 2023.

Easing in the East: In Asia, central bank policy stands in sharp contrast to its western counterparts. The Bank of Korea and Reserve Bank of India are on a sustained hold after hiking rates 300bps and 250bps respectively, while the Bank of Japan (BOJ) and People’s Bank of China (PBoC) continue to maintain supportive monetary policy.

The BOJ has heralded ultra loose monetary policy through the coordinated global tightening effort and despite rising inflation and significant currency devaluation. Since taking the helm in April, Governor Kazuo Ueda has pushed back against any speculations of a policy pivot, arguing that while the country has seen meaningful inflation following a decades-long period of disinflation, the target rate has yet to be sustainably achieved. But in a contradictory, and slightly confusing, move at the July meeting, the BOJ introduced greater flexibility in its yield curve control policy. While the move did not officially widen the control band and monetary easing remains in place, it had markets hopeful for a policy reversal later this year with the futures market now pricing in a 27% possibility of a rate hike by year-end.

Policy divergence accelerates across global central banks. Looking ahead, markets should expect a far less synchronized picture than what the world has recently been used to. Following a year and a half of central banks hiking rates in lockstep on an unprecedented scale, policy makers are starting to forge their own paths. The Fed—having led the most aggressive tightening campaign both in terms of both quantity and speed of hikes—looks closest to the finish line, although its counterparts across the pond seem to be close behind. Meanwhile, other central banks across the world remain on a sustained pause, continue to ease or are entering the early days of tightening. As the impact of monetary policy—both tightening and easing—works its way through regional economies, we expect market cycles to decouple. This regional dispersion will create heightened opportunities for active managers.

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Lara Rhame

Chief U.S. Economist + Managing Director

Madison Murphy

Associate, Fund Communications

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