THINK Ahead: This is what’s really keeping central banks up at night
The core argument posited by the desk emphasizes that persistent supply shocks pose an increasing threat to central banks, complicating their inflationary outlook and monetary policy strategies. Per the full note source, analysts suggest that this cycle of shocks, fueled by various factors like semiconductor shortages and climate impacts, raises concerns over entrenched higher inflation. With the correlation between stocks and bonds shifting positively for the first time in decades, investors might face a more volatile financial environment where both asset classes could decline simultaneously. Such dynamics necessitate vigilance in macroeconomic indicators, particularly employment figures, as signals for central-bank actions moving forward.
What the desk is arguing
The desk argues that recurring supply shocks are likely to lead to higher and sustained inflation, prompting recalibrations in central bank rate policies. According to the source, Federal Reserve officials are now reconsidering their stance on needing to raise rates to combat inflation after years of overshooting their target levels. This shift in thinking presents significant challenges for both equity and bond markets, potentially ushering in periods of co-movement where both asset classes face downward pressure.
The evidence for this scenario is found in the observed positive correlation between bond and stock prices, which has emerged for the first time in over 20 years. Such a dynamic, as highlighted by Michiel Tukker's analysis, signals a fundamental change in how market participants must manage risk and portfolios moving forward.
Where it sits in our coverage
Our consensus target for the EUR/USD pair aligns at 1.075, with a range spanning from 1.04 to 1.12, as noted by several prominent firms: - jpmorgan: 1.10 (Mar-26) - bofa: 1.04 (Mar-26)
The desk’s perspective closely reflects the broader consensus, landing in the lower-middle range of our collective targets. This suggests a cautious stance in the face of the evolving supply-side inflation narrative espoused by central banks, particularly the Fed and ECB.
How other firms see it
Overall, aligned firms like jpmorgan and nomura echo the desk's concern over supply-side inflation pressures, predicting continued rate adjustments. On the contrary, bofa presents a narrative that leans towards a more optimistic outlook on inflation returning to target.
A sharp focus on EUR/USD movements will be critical, especially as the European Central Bank's actions could provide insight into broader currency responses. Observing U.S. inflation data and central bank meetings will also be instructive as both sets of decisions are likely to impact market sentiment and currency pair behavior significantly.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Supply shocks could lead to sustained higher inflation, altering central bank strategies.
- 02Positive correlation between stocks and bonds signals increasing market volatility.
- 03Investors should closely monitor employment data and central bank communications.
- 04A shift in macroeconomic indicators may redefine financial market dynamics.
Market implications
Traders should watch for key levels near the consensus target of 1.075 in EUR/USD as macroeconomic data, particularly employment statistics, are released. The changing risk landscape suggests positioning for higher volatility across asset classes in anticipation of shifts in central bank policies.
Risks to this view
The primary risk to this outlook lies in a stronger-than-expected recovery in supply chains, which could alleviate inflationary pressures faster than anticipated, prompting central banks to maintain or lower rates. Additionally, if central banks decisively communicate a commitment to combating inflation effectively, it might quickly change the market's risk appetite.
Opinions Opinion by James Smith THINK Ahead: This is what’s really keeping central banks up at night Published 11:32 What if the supply shocks just keep on coming? From semiconductors to hot weather, there's no shortage of potential risks. Yet against a backdrop of a cooler jobs market, James Smith argues the case for a fresh inflation wave is far from convincing Source: Imgflip This is what’s really keeping central banks up at night Long-suffering readers will know I like to talk in memes.
And you’ll know this one surely: a wife lies awake at night wondering whether her husband is thinking about another woman. Beside her, he stares silently into the darkness. In fact, he’s wondering whether the global economy is trapped in a cycle of recurring supply shocks that keep inflation permanently above target, upending decades-long norms in financial markets. (What a time to be alive in the Smith household…) This is perhaps the biggest question in the world of economics right now.
Each supply shock comes with good reasons to be ignored by central banks. But after five years of above-target inflation, Federal Reserve officials are starting to question whether, when added together, these shocks warrant higher rates. The European Central Bank has already made that call.
That thinking is hugely problematic for investors. If supply shocks really are becoming more frequent – and we get more periods where inflation rises at the expense of economic growth – then we’ll see more periods where bond and stock prices fall together. As my colleague Michiel Tukker's chart shows, the five-year rolling correlation has recently turned positive for the first time in over two decades.
The traditional role of bonds as a hedge is being eroded. The correlation with bonds and stock prices is increasingly positive Source: Macrobond, ING "> Source: Macrobond, ING Given the world we live in, it’s hard to argue that these shocks are going to become less frequent. Yet for the time being at least – and notwithstanding the uncertainty in the Middle East – I’m yet to be convinced the next storm is brewing.
Take semiconductors. The shortage is beginning to push up the price of some consumer electricals. US software and accessories are up almost 20% in price so far this year.
Yet added together, I reckon the goods most exposed to ‘chipflation’ make up a mere 1.3% of the US inflation basket. What’s more, the statisticians will offset some of those price rises to account for technological advances. Admittedly, the risk could multiply if car prices start to surge.
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