Market questions central bank credibility

Central banks and governments have responded to the economic havoc caused by Covid-19 with unprecedented levels of both fiscal and monetary stimulus. However, as vaccines are rolled out and economies reopen, continued expansion of fiscal policy would confirm our long-held view of arriving fiscal dominance (i.e. when an indebted economy requires monetary support to stay solvent), alongside the likelihood of higher inflation and the increased risk of a taper tantrum in markets.

The quantitative easing deployed following the spring 2020 lockdown is very different from what we saw after the Global Financial Crisis. The primary role of central bank balance sheet expansion this time has been to facilitate fiscal spending rather than to support financial conditions. As part of our analysis, we have mapped out this highly abnormal environment and what its consequences might be.

Composition of nominal yields matters for risk assets