: Intensifying risks to global growth raise possibility Fed, ECB, or both will ease again in 2022, strategist says

Win McNamee/Getty ImagesGeopolitical tensions are intensifying risks to global growth and even raising the possibility that two of the world’s leading central banks may be easing again this year.That’s the view of TD Securities’ head of global strategy, Rich Kelly, who says the “modern-day blockade” of Russia’s economy has led to an “illiquidity bubble” around Russian assets that’s so far contained, although “illiquidity begets credit defaults, and that is the more uncertain phase for markets to navigate next.” Over the past week alone, he notes, markets have priced out 50 basis point hikes from the Fed and European Central Bank.Kelly’s scenario of central-bank easing this year despite higher inflation adds a new wrinkle to the binary risks posed by Russia’s invasion of Ukraine, and goes beyond the market’s two prevailing views. The first view is that inflation is poised to go even higher on rising energy and commodity prices, and should theoretically be forcing central banks to hike aggressively, not to ease. The second view is one of an economic slowdown, which already has fed funds traders dramatically pulling back on expectations for a half-point hike from the Fed in two weeks, but not yet factoring in rate cuts. Indeed, Fed Chairman Jerome Powell told lawmakers on Wednesday that he supports a 25 basis point rate increase at the central bank’s March 15-16 meeting.Read: Powell signals 25 basis point rate hike is coming at policy meeting in two weeksThe Fed, which is about to begin its first rate-hike campaign since 2015-2018, has left the fed funds rate target between 0% and 0.25% since March 2020. Meanwhile, the ECB has left its benchmark refinancing rate at 0%, the rate on its marginal lending facility at 0.25%, and the rate on its deposit facility at -0.5%. Last month, ECB President Christine Lagarde wouldn’t rule out a 2022 rate hike amid a “tilt to the upside” in inflation risks, and financial markets had been pricing in faster-than-expected European rate hikes though she pushed back on that speculation. A chart prepared by TD Securities, a part of Toronto-Dominion Bank TD , shows that the Fed would need to hike the fed funds rate target by 800 basis points immediately in order to match its typical reaction function relative to past decades. But such a dramatic rise in the U.S. policy rate isn’t seen as realistic by many. Haver, TD SecuritiesThe U.S. central bank conceded late last year that its expectations for transitory inflation were off base. Now, Powell is telling lawmakers that while the Fed expects inflation to peak and subsequently come down, it’s also prepared to move by more than 25 basis point increments if that doesn’t happen. “Perhaps the only certainty at the moment is that everyone’s forecasts are wrong,” Kelly wrote in a note Wednesday. “It is reasonable to ask whether the ECB and/or the Fed will be easing again this year, even if their next steps are toward tightening.”For now, Kelly says, TD Securities holds the view that G-10 central banks will start to gradually tighten, while a faster pace is likely to be in store for emerging markets. On Wednesday, Treasury yields bounced higher across the curve, with the 10-year rate BX:TMUBMUSD10Y breaching 1.8% during Powell’s testimony to the House Financial Services Committee and rising more than 10 basis points on the day.

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