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 , 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.
They’re stuffed full of chips these days – and the pandemic showed how disruption to car production can spill into used prices and subsequently that of insurance, leasing and rentals. More likely though, as James Knightley explained to me in a webinar this week , the overall inflationary impact of the semiconductor squeeze is likely to be minimal. Categories exposed to semiconductors are a drag on US inflation Source: Macrobond, ING "> Source: Macrobond, ING The same is true when it comes to AI’s hunger for electricity.
The grid is a key constraint to the rollout. But like those electronic goods, the weight of electricity in the CPI basket is relatively small, too. And all those data centres tend to be fairly localised – and as Coco Zhang explains , are increasingly sourcing their own power ( sign up for our webinar on this next week).
It’s not clear that this is a big inflationary threat nationally. Then there’s Europe’s weather woes. Higher temperatures mean more air conditioning, adding yet more pressure to natural gas prices.
They’ve spurred dangerous fires. And the corresponding lack of rain has also drastically lowered Europe’s water levels. The depth of the Rhine at the German chokepoint of Kaub hit just 20cm this week – a full 170cm below the prior 10-year average.
Ships are having to run at a fraction of their typical cargo capacity. And Carsten wrote this week that this could shave 0.3ppt off German growth this year. It’s an issue for supply chains – and even electricity grids.
Valentin Tataru writes about Romania’s struggles with the Danube River and nuclear power. Rhine water levels are dangerously low Source: Macrobond, ING "> Source: Macrobond, ING In the end though, all of this is a short-lived crisis for the summer. It’s unlikely to have a lasting impact on inflation – even if it is an unwelcome reminder that these climate impacts are becoming more potent.
Just think of El Nino, which is currently pushing up oceanic temperatures in parts of the Pacific. The Bank of England recently singled this out as a potential upside risk to inflation. Not so much because of the impact on food inflation, which our team expects to be contained (and has been falling recently, despite the Middle East situation).
But because of the wider impact on the Panama Canal. Authorities are already having to apply shipping restrictions in response to lower water levels and the risk is that gets worse. Still, nothing here strikes me as a major source of upside risk for inflation over the coming 12 months or so.
And when taken together with the fading hit from tariffs and lower rental growth, James K thinks the Fed can still get away with holding interest rates this year – though clearly next week’s price data will be key (more on that below). There’s a bigger point here though: History tells us that supply shocks only become truly dangerous for central bankers when they collide with a jobs market capable of propagating them. Workers need enough bargaining power to recover lost purchasing power through higher wages.
Firms need enough pricing power to pass rising costs on to consumers. That is how temporary price increases become persistent inflation. And none of this is especially true today.
Jobs markets have cooled markedly from their post-pandemic extremes – as today’s US payrolls shocker demonstrates. The re-acceleration in America's labour market, which underpinned the Fed's recent hawkish pivot, really doesn't seem to have lasted. And it echoes why there's little sign of wage growth emerging on either side of the Atlantic.
The conditions that allowed the inflation shocks of 2021-22 to become deeply embedded are largely absent. Supply shocks may be getting more common. Price changes may well become more volatile.
But without the fuel of a tight jobs market, the inflation fire can only spread so far. That’s why, from the Fed to the Bank of England, we expect interest rates to undershoot what markets are currently expecting. James Smith Why Fed Chair Kevin Warsh could make markets more volatile Warsh's scepticism towards forward guidance could result in greater market volatility, says ING's FX Strategist Francesco Pesole, although Warsh cannot stop other Fed members from making their own views known.
Pesole shared his views in a recent webinar with Developed Markets Economist James Smith. THINK Ahead in developed markets United States (James Knightley) July CPI (Wed): July US consumer price inflation will be the main release to watch. June’s report was very benign, with softness spread across a number of categories, while falling gasoline prices pulled the headline price change down by 0.4% month-on-month.
July has seen more volatility in motor fuel costs, but on balance they are a touch lower than in June and, as such, we are hopeful of another relatively benign outcome of 0.1% MoM. Core inflation is going to be a little more elevated, but with weak wage growth, tariff refunds giving US corporates a cash flow boost, and housing costs cooling, we are hopeful of a 0.2% outcome. The consensus amongst economists is split fairly evenly between a 0.2% print and a 0.3% print for core inflation.
Market reaction may be fairly limited given we have another jobs report and inflation report ahead of the 16 September FOMC meeting. July Retail Sales (Fri): Retail sales will also be closely followed given consumer spending accounts for 70% of all US economic activity with retail sales responsible for around 43% of that spending. Auto sales volumes were flat, while gasoline station sales should be pulled lower by price falls, with the rest of the components showing modest growth.
The 250th anniversary of US independence and the FIFA World Cup may have lifted activity in the first half of the month, particularly for groceries and eating/drinking out. UK (James Smith) 2Q GDP (Thu): Solid second quarter growth is more a reflection of the faster momentum through the latter stages of the first quarter. Monthly GDP numbers have been running less hot through April/May, and we expect that to continue into June.
Survey indicators look less strong than the headline GDP figures, and we continue to think some of the strength through the first half is down to issues with the seasonal adjustment of the data. Key events in developed markets Source: Refinitiv, ING "> Source: Refinitiv, ING Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument.
Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download In this opinion This is what’s really keeping central banks up at night THINK Ahead in developed markets Author James Smith Developed Markets Economist, UK James is a developed market economist, responsible for ING's view on the UK economy and Bank of England. He graduated from the University of Bath with a degree in economics and joined ING in 2015.
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