Markets also know that central banks will be incredibly wary of raising interest rates too soon and potentially stifling a nascent recovery. Is there a tendency to act too late rather than too soon?
Rate hikes would increase borrowing costs for governments, which could respond in two ways. They could limit borrowing by raising taxes, cutting spending, or a combination of the two. Or they could fight the hikes with even larger deficits, which would raise inflation further, possibly leading to more interest rate hikes.
Alternatively, central banks could appear to use their monetary powers to support the prices of government securities and reduce the costs of servicing sovereign debt. It flirts dangerously close to “fiscal dominance,” the erosion of central bank independence and, you guessed it, spiraling inflation.
So we’re in a long money chicken game over the next few months, with central banks trying not to raise rates, while claiming they could and hoping the markets won’t bluff. It’s not hard to predict that the markets are going to experience an incredibly bumpy ride over the next few months, as every wandering data is overinterpreted and every central bank statement is guessed.