Central bank policy updates and the impact on fixed income investors 

Investors closely monitoring the communications provided by central banks in Europe and North America may have already noticed a curious pattern in their recent public comments. In the case of the Fed, voting members of the FOMC are split on the path of rate hikes moving forward, and are engaging in a game of good cop – bad cop, with some members stating the hiking cycle is far from over, while others claiming the FED is close to overdoing it. 
Hawkish members such as San Francisco Fed President Mary Daly stated that a pause is off the table for the time being, and that they will likely require rates to be in the 5% range before this is even discussed. She stressed the importance of the raise and hold strategy the Fed is engaged in, but conceded that once rate hikes are put on hold and inflation comes down, monetary policy would become too tight and may warrant gradual decreases, though no timeline was placed on this process.

Likewise, St. Louis Fed President James Bullard echoed the sentiment in a comment made on Nov 17th where he stated, “the policy rate is not yet in a zone that may be considered sufficiently restrictive,” suggesting there is still a way to go before rates become sufficiently restrictive. Bullard went as far as to say that the 5-7% range may be more likely, putting his own targets far above the markets’ and the Fed’s own predictions of 5%. 
Markets reacted to the two Fed Presidents’ comments and 10-year yields increased by 13 basis points between Nov 16th and 17th, ranging from 3.69% to 3.82% at the high.
On the other side of the debate, is Lael Brainard who is more optimistic of the Fed’s impact on inflation, considering that various metrics used by the FOMC have been posting lower than expected inflation numbers over the last few months. Brainard answered questions during a live interview on Nov 14th, and was quoted as saying “I think it will probably be appropriate soon to move to a slower pace of rate increases”.

What are investors supposed to take from the mixed messages provided by Fed members? One theory is a game of Good Cop - Bad Cop, where hawkish members aim to tame the market’s expectations and avoid an unwarranted rally, while the good cops take a more sensible approach to avoid panic and a potential credit crunch.

ECB at a crossroads

Although the Fed is arguably the most influential Central Bank in the world, investors often forget the ECB is in charge of setting monetary policy for a group of nations with a combined GDP of +$16 trillion, and with vastly different economic landscapes and conditions. 
The economic fragmentation that exists in the EU makes it difficult for the ECB to set a one size fits all policy, as evidenced by the Spanish Economy Minister, Nadia Calvino, who stated on Nov 18th that Spain’s own inflation is gradually moving lower while other European nations are grappling with double digit numbers.

The contrast was evident in the speech from ECB President Christine Lagarde, who spoke in Frankfurt on the same day. After an unprecedented 200 basis points hike since July, she expects rates to rise further, and settle into restrictive territory. Most estimates of the neutral rate are between 1.5-2%, suggesting the ECB will have to go higher than this to slow growth, and inflation.

However just as in the United States, not all members of the ECB are on the same side. Interestingly Fabio Panetta, a member of the ECB's board, argued that excessive hikes could deepen a downturn, and compress demand and output permanently below trend. 

What this means for investors

If there is one thing the market does not like it is uncertainty, of which there appears to be plenty. As is the case with Central Banks worldwide, fixed income investors must remain data dependent and pounce on any opportunities caused by a divergence in policy response. 
Allocating funds towards fixed income ETFs made up of medium to low duration assets will help minimize the risks of higher than expected rates, while taking advantage of yields in the middle of the curve.