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No Time to Blink

May 6, 2022

Jimmy Jean
Vice-President, Chief Economist and Strategist

Like the Bank of Canada a few weeks before, the Federal Reserve (Fed) delivered a supersized rate hike on Wednesday. It also announced that quantitative tightening would begin on June 1. The Bank of England hiked by only 25 basis points this week, though it continued to tee up outright sales of government bonds—a step no other major central banks have taken since they started using their balance sheets as policy tools.

These moves are forceful but necessary, as we continue to see upside risks to inflation materialize. This week, the President of the European Commission proposed phasing out imports of Russian oil and refined products over six months. This comes after the European Union set a target to cut Russian gas imports by 66% by the end of the year. Crude oil prices rose on the news, and that momentum could be sustained if Russia decides to cut oil exports to Europe in retaliation, similar to how it cut off gas supplies to Bulgaria and Poland when they refused to pay in rubles.

We can’t look to China for comfort. New COVID‑19 cases may be receding, but authorities have reaffirmed their goal of achieving zero community transmission before lifting lockdowns. And the reopening of the Chinese economy won’t help cool inflation in the near term. Chinese lockdowns did prove helpful in one sense, as they temporarily dampened global oil demand. When economic activity recovers in the world’s second-largest oil consuming country, so too will demand and prices for oil and other commodities. This impact will most likely be felt sooner on inflation than the relief effect that will eventually come from improving supplier delivery times. Given these recent developments, we’re raising our year-end target price for WTI crude oil from $88 to $96.

In light of current conditions, we’ve been arguing that central banks would need to lift interest rates towards neutral expeditiously. However, this week the Fed effectively put a cap on how much it will be willing to move at each meeting. This is a major shift in tone. Not even a month ago, central bankers refused to rule anything out. Obviously markets picked up on this shift on Wednesday, as equities rallied, bond yields fell and market-based inflation expectations rose. For a central bank contending with 8.5% inflation, a meeting that ends with financial conditions easing can hardly be deemed a resounding success. The remainder of the week was characterized by wild market swings. These can be chalked up to a number of developments, although confusion about the monetary policy outlook and recession risks remained a dominant theme. The credibility of central banks is on the line, and that means they can’t show the slightest sign of weakness. So until neutral is within sight, there’s no time to blink.

Read the full commentary: No Time to Blink