The Macro Unravelling

The Bank of Japan's move to loosen yield curve control is just one illustration of how forces like inflation are sowing chaos in the normal rules of macro and markets.

The Macro Unravelling

FRANKFURT AM MAIN, GERMANY - NOVEMBER 14: Haruhiko Kuroda, Governor of the Bank of Japan, in a ... [+] panel to discuss central bank communication on November 14, 2017 in Frankfurt, Germany. The event, which is taking place at European Central Bank headquarters, is part of a two-day conference on central bank communication. (Photo by Hannelore Foerster/Getty Images)Getty Images

We think that the emerging strategic competition will contribute to an unravelling of the macro policy order. Indeed, previous episodes of global regime change have had disruptive effects on macro policy approaches and institutions. For example, the pressures of funding the Vietnam War, the Cold War, and the Great Society programmes in the US, led President Nixon to unilaterally move the USD from gold peg. Macro policy rules were not compatible with broader strategic objectives. Similar pressures will become more evident in 2023. The pace of interest rate increases will likely slow next year, and on a net basis there may well be more rate cuts than rate increases as the global economy slows. But we do not expect inflation to go away quickly. Labour markets are strong and in many countries consumer balance sheets are healthy. Demographics, solid labour markets, frictions on globalisation, and volatile energy markets will also contribute to structural inflation pressures. We expect inflation to drop but to remain stubbornly above target. As a result, interest rates will also remain at a high plateau. The persistently expensive cost of money will provoke and discover many macro risks: over-leveraged consumers; parts of the US, Australian and Canadian housing markets; the riskier end of the European corporate bond market and periphery bond market. In emerging markets, the risk of a debt downturn in China is the one that looms largest. Varying levels of national exposure also mean that different central banks that have varying freedom of manoeuvre: this ‘central bank inequality' will shape currency moves. Overall, economic and market turbulence is likely. At the same time, growing pressure is likely on the prevailing macro policy regime – fiscal rules with a focus on sustainability, independent central banks with a price stability target – that has been in place for the past 30 years. In response to the debris of the previous regime (high inflation, soaring public debt levels, and weak economic outcomes), policy rules were established to depoliticise macro policy.

Central banks

However, the shift to a war-time economy will challenge this regime, with increased government spending and investment running into the constraints of current fiscal rules. And the higher interest rates that would be expected as central banks respond to above-target inflation will compromise the ability of governments to fund its strategic priorities.

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This conflict between existing rules and new realities will likely lead to growing tension between politicians and central bankers. If there is a sustained push higher in rates, we may see central banks pressured to manage them lower than they reasonably should be – with resulting swings in currencies as markets price in weaker policy rigour. This will create the context for structural changes to the macro policy order. If the choice is between strategic priorities and existing macro policy institutions, we suspect it is the institutions that will give. There is some evidence of these pressures already emerging: debates about central bank independence and the appropriate target specification; as well as renegotiation of fiscal rules (for example, the EU fiscal framework). Governments will be moving from policy rules to policy discretion, where macro policy institutions are subordinated to higher-level strategic objectives. This may already be the case in Japan. In its place, we should expect (de facto, if not always de jure) a relaxation of fiscal rules and softer inflation targets, perhaps with diminished central bank independence. QE will be difficult to end.

The implication is that higher trend inflation is likely as macro policy remains accommodating. Non-traditional measures to manage inflation, such as price caps, are possible responses. Inflation is politically challenging as discussed above. This may seem like a tail risk, but the logic of a war time economy pushes in this direction – and more evidence of this shift should be expected in 2023. Higher levels of economic and market turbulence are likely on the back of this less rules-bound approach to macro policy.

Dominant dollar

The USD will remain dominant. But there may be some changes in the global financial system, as countries seek to reduce their exposure to US monetary policy. As one example, it seems unlikely to us that the HKD peg can be sustained given the rivalry between the US and China. And official reserves will continue to be diversified. We should also expect a continuation of currency frictions; exchange rates are a tool for strategic competition.


Firms and investors need to position for a higher trend inflation world, with higher interest rates (although perhaps low in real terms), and with a measure of non-conventional responses.

There will be a growing performance differential between cashflow ‘strong' companies with lower debt and those that are exposed to policy changes and have higher debt.

Equally, markets will differentiate sharply between those countries that can ‘get away' with easier policy (Switzerland) versus those whose reputation is tarnished (UK).