“If markets do not conclude from this that prices will remain high for longer, We will have to use our price levers and raise interest rates to get where we want to go“.

The price cut bets have piled up Central banks have come even closer, as everything central bankers say – no matter what – is either interpreted as “dovish” or ignored.

The slogan “Powell was dovish” has been spreading across the Internet after every FOMC news conference since June 2022. In early 2022, just as the Fed began raising interest rates, bets were already being made on rate cuts later in 2022.

Then came the bets on a rate cut in 2023, and now there is only one meeting left, and still no rate cuts. So the heavy breathing over interest rate cuts has shifted to 2024, and the cuts are getting bigger and closer.

Meanwhile, central bankers at the Fed, Bank of Canada, European Central Bank, Bank of England, Reserve Bank of Australia, etc., have been flogging their arms to cut interest rate bets.

The Reserve Bank of Australia finally got the chance and raised interest rates by 25 basis points in November after a long pause.

There is a problem with markets betting against central banks. Central banks are “tightening” in order to tighten financial conditions in markets – including higher long-term yields, wider spreads between government debt and risky debt, such as junk bonds, and so on.

These tighter financial conditions make borrowing more expensive and difficult for businesses and consumers, which should then slow economic growth and take out some of the foam, thus putting the kibosh on inflation.

But it doesn’t work when financial conditions are loose, with long-term interest rates falling and spreads narrowing, because markets are betting against central banks.

Thus, European Central Bank Governing Council member Pierre Fonche made it clear – and no one in the markets listened to him: that these bets on lowering interest rates could in fact lead to the opposite: raising interest rates.

“Would it be a problem if everyone thought we were going to cut production?” Winch said in an interview with Bloomberg. “Then we have less restrictive monetary policy. I’m not sure it will be restrictive enough. So that increases the risk that you have to correct in the other direction.”

“I think markets are relatively optimistic today because they rule out the possibility that we have to do more or that we have to stay at 4% for a longer period,” Funch said.

“If we come to the conclusion that inflation is not falling fast enough, we will announce that through our forecasts and through our communications,” he said.

“If markets do not conclude from this that prices will remain higher for longer, then We will have to use our price levers and raise interest rates to get where we want to go“.

This is what the Reserve Bank of Australia did earlier in November when it raised interest rates by 25 basis points.

Funch does not expect any interest rate rises at the ECB’s next two policy meetings, thanks to “recent marginal positive surprises on inflation.”

“This moves the question to the next uncertainty: Are we going to see some inflation resistance at some point at 3% or something like that because of wages?” He said. “That’s something we won’t know by December or January.”

It’s almost funny how markets have been betting against central banks since they started tightening monetary policy. But recently, those bets have turned into a furious party, and as a result, financial conditions have eased a lot, rather than tightened.

In the United States, there are several measures that track financial conditions. For example, the Federal Reserve Bank of Chicago’s weekly National Financial Conditions Index (NFCI) relies on 105 measures of financial activity to track conditions in money markets, debt markets, equity markets, the banking system, and the shadow banking system (what goes into this is explained here ).

For the week ending November 17, the index showed further decline, with the index value falling to -0.47, the lowest level since February 2022, before the Fed began raising interest rates.

The Federal Reserve, the European Central Bank, the Bank of Canada, the Reserve Bank of Australia, and the Bank of England were facing the same problem: markets were not cooperating – markets were fighting them, and financial conditions became looser, thus providing additional fuel for inflation, the longer markets remained in recession. By doing this, the greater their risk that interest rates will eventually rise for a longer period. NFCI of the Federal Reserve Bank of Chicago:

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Editor’s note: The summary points for this article were selected by Seeking Alpha editors.