Words and action

Key points

• The message from COP26 may be that we need to focus less on generic pledges and more on implementation.
• It has been a momentous week for central banks, with the Federal Reserve coming out with the least drama.
• Tapering is not necessarily consistent with an equity market correction. It’s when central banks start reducing the size of their balance sheet, rather than merely stabilizing it, that things could get tougher.

Those who like to see their glass half full will want to focus on progress seen at COP26 last week, such as the announced conversion of India to “net zero” (albeit by 2070 only) or the ambitious deal on methane. However, it is disheartening that the world’s top two greenhouse gas emitters, the US and China, as well as India, refused to join the agreement on phasing out coal. Politics are getting in the way in the US, while China’s experiment last summer with a “coal-free diet” ultimately illustrated the country’s dependence on this most harmful form of fossil fuel. This week there could be progress on the so far intractable negotiations on international carbon trading, but we feel the main conclusion of this COP is that focus may now be moving away from generic pledges – as important as they are – towards implementation monitoring. We reiterate our view from last week: trade policy could well become the main channel for “carbon geopolitics”, potentially at a sizeable economic cost for all stakeholders.

Meanwhile, central banks had another momentous week. Probably more than the European Central Bank’s (ECB) Governing Council members who have lined up to push back against aggressive market pricings of the policy rate lift-off, it’s the Bank of England’s decision not to be proceed with the rate hike it had telegraphed to the market which may have pushed expectations for the first ECB hike back into 2023. As the Bank of England has “bottled it” despite more acute inflation risks in the UK than in the Euro area, this shows the bar for early monetary tightening is high. There is a price to pay in terms of credibility for the British central bank though. Conversely, the Federal Reserve (Fed) had an easy week with Jay Powell defying market expectations of an endorsement of a rate lift-off in 2022, thus cushioning the impact of the announcement of tapering. The Fed’s willingness to retain maximum optionality is a double-edged sword though. While so far, the market has taken it on the dovish side, the central bank’s explicit doubts on where full employment is in a post-Covid world could ultimately convince the Fed to hike quite quickly.

We are not surprised by the equity market’s absence of reaction to tapering. In a recent paper we quantified the impact of quantitative easing on stocks. It’s only when the Fed starts reducing its balance sheet – i.e. sells back the paper it has bought – that equity prices would fall. We have time to think about this.