Hitting the (conditional) pause button

Central banks and ‘hawkish’ pauses

As a parent, making things conditional is a powerful tool. You can get your allowance if you do your chores. You can’t go out with friends if you don’t get your homework done. As the mother of a teenager, this is my personal favorite: You won’t be allowed to drive the car anymore if you don’t keep it clean. Our daughter’s car has, at times, come to resemble a rolling garbage can, and it can be a soul-wrenching, nauseating experience to try to sift through the debris of fast food containers, athletic gear and random clothing and beauty products. (The worst part is the liquid goop in the cupholder, which seems to be the result of several different seasonal Starbucks drinks that have chemically combined with hot chocolate.) But once we laid down the law and set conditions on the use of the car, it has been quite clean (although admittedly not Felix Unger level clean).

Conditions – more specifically, conditional pauses – can be powerful tools for central banks as well. They allow central banks to take a breather and give their respective economies time to digest previous rate hikes without being viewed as dovish – which could result in a premature easing of financial conditions. Central banks recognize the dangers inherent in having a significant time lag between policy implementation and its impact on the economy.

A pause can give central banks the time to analyze data and be thoughtful about policy going forward. At the same time, central banks recognize the danger of inflation becoming entrenched. Conditional pauses carry with them the power to reinstitute rate hikes if needed. They send the message that rate hikes may not be over and that central banks are being vigilant about the risks of inflation. To put it simply, they serve as proverbial swords of Damocles, hanging over markets.

Examples of conditional pauses

Two recent examples of conditional pauses are the Reserve Bank of Australia (RBA), which instituted a conditional pause in April, and the Bank of Canada (BOC), which announced its conditional pause back in January.

I thought it made sense that these pauses were conditional given the dramatic number of rate hikes in a relatively brief period of time, but also given very real concerns about the stickiness of services inflation. A conditional pause can achieve the dual goals of buying time to assess more data and continuing to control inflation and inflation expectations. As the BOC explained in January, “With today’s modest increase, we expect to pause rate hikes while we assess the impacts of the substantial monetary policy tightening already undertaken. To be clear, this is a conditional pause – it is conditional on economic developments evolving broadly in line with our (Monetary Policy Report) outlook. If we need to do more to get inflation to the 2% target, we will.”¹

Earlier this month, the RBA and BOC both decided to hike rates after enacting conditional pauses. I found the BOC decision to hike its policy rate to 4.75%, a 22-year high, to be particularly important since Canada has been something of a first mover when it comes to monetary policy. While the RBA decision was a surprise, we knew a BOC rate hike was a very real possibility since the last Consumer Price Index print showed higher inflation than expected – Canada’s first monthly increase in 10 months.

Those hikes were important because central banks’ policy decisions can prove infectious, convincing other central banks to hike rates too. In fact, in its decision, the BOC made it clear that it is paying attention to what other central banks are doing: “major central banks are signalling that interest rates may have to rise further to restore price stability.”² However, the Federal Reserve took a “hawkish pause” in its meeting on June 14, a move that I believe is a prudent one.

How have markets reacted?

The S&P 500 Index seemed undeterred by rate hikes in Australia and Canada, perhaps soothed by last week’s U.S. initial jobless claims, which rose for the third consecutive week, clocking in at 261,000 – well above expectations.³ In fact, the S&P 500 entered a new bull market earlier this month, up over 20% from its Oct. 12, 2022, low of 3577.03.⁴ However, leadership has been narrow with a small number of tech stocks largely powering the rally. I think there are legs to this rally, given that FOMO (fear of missing out) is driving more investors into stocks right now, but I also believe there are potential potholes in the near term given uncertainty about Fed policy.

It's also worth noting the strong performance of Japanese stocks. The Nikkei 225 Index recently closed at its highest level since 1990; it is up well over 20% year-to-date.⁴ The combination of Japan’s post-Covid, better-than-expected economic growth and still-supportive monetary policy helped fuel these gains.

It will hopefully serve as a reminder of the opportunities that exist outside the U.S.

Kristina Hooper is Global Market Strategist at Invesco. With contributions from Arnab Das.

Notes

1. Source: Bank of Canada Governor Tiff Macklem, Monetary Policy Report Press Conference Opening Statement, Jan. 25, 2023.
2. Source: Bank of Canada Statement, June 7, 2023.
3. Source: Bureau of Labor Statistics, June 7, 2023.
4. Source: Bloomberg, L.P., as of June 9, 2023.

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The opinions referenced above are those of the author as of June 12, 2023. These comments should not be construed as recommendations, but as an illustration of broader themes. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

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This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

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