Faced with rising prices that are beginning to seriously worry the markets, the U.S. Federal Reserve (Fed) announced on December 15 that it would tighten its monetary policy: its purchases of government debt, which were initially scheduled to end in June 2022, will be stopped as of March. In the same move, the key interest rate, held at zero since March 2020, could be raised three times next year. The next day, the European Central Bank (ECB) followed suit and announced that it would end its sovereign debt purchases (the Emergency Purchase Programme, EPPP) in March, as well. The ECB claims to be "independent", but it seems to be singularly subservient to the Fed, unless it is a "coordination"; we'll let you be the judge...

So, inflation is coming back but central banks are reacting. Is it a done deal?

The problem is that there has already been so much money printing and such an explosion of central bank balance sheets, that the damage is done. Moreover, debt buybacks will continue, at a lower level: when a bond matures, the ECB will use the money received to acquire other debts, so as to keep its balance sheet stable (it is only the net buybacks that are stopped). In effect, by reducing its balance sheet, the ECB would put too much pressure on the bond market, with the risk of a crisis.

 

 

It seems that central banks did not understand, or admit, that they were the main cause of inflation (as I explained), and that they were deluding themselves about real but secondary causes (rebound of growth after the lockdowns, various shortages while factories restart, logistic chains bottlenecks). These causes do exist, of course, but the price increase has existed since the early 2000s, when the Fed and the ECB started their monetary laxity, and this has been seen in the prices of investments and real assets (real estate, stocks, gold, works of art, collector cars). This time, consumer staples are affected (energy, food, durable goods), as money printing has exploded all previous records. The central banks think that these cyclical causes linked to the economic recovery will fade away and that, as a result, inflation will wisely return to below 2%. They are wrong.

Finally, such a reduction in debt purchases will cause medium and long-term interest rates to rise. If the Fed and the ECB buy less, private investors will have to compensate, and it will be at a higher rate of return. Can the US federal budget handle it? Can the deficit countries of the eurozone avoid default? For several years now, the amount of public debt has been rising, but its burden on the budget (the interest to be paid) has been falling, thanks to the fall in interest rates. We are at the bottom, and if rates go back up, the backlash will be severe. Not to mention, the banking sector and the zombie companies that would be hit hard.

We rather think that the Fed and the ECB have only made an announcement in order to reassure the markets and to restore their credibility, but that they will not hesitate to change their agenda at the slightest difficulty ("the Omicron variant forces us to push back the March deadline"...). There is now too much debt in the economy, everywhere and at too high a level. The room for maneuver of central banks is considerably narrower...