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Improving Economic Conditions Will Force Interest Rates Up

Though the central bank will begin to taper back quantitative easing, Hatzius believes it will also find a way to tweak its “Forward guidance” efforts.

While the Fed is in the spotlight, it’s not the only central bank that is trying to lean more heavily on forward guidance these days – these “Open-mouth operations” are currently all the rage at the Bank of England, the European Central Bank, and the Bank of Japan as well.

Investors don’t think central banks will be successful with these new forward guidance tactics, which are expected to ramp up soon.

“Most clients I met buy our story that the Fed, the Bank of England and the ECB will step up their efforts to push back on expectations of earlier and faster rate hikes in the next few weeks and months,” says Morgan Stanley global head of economics Joachim Fels in a Sunday note.

In other words, despite continued efforts by central banks to keep interest rates low, improving economic conditions will force interest rates up.

“Too much is at stake for central banks in terms of credibility and there are various ways to make forward guidance more precise and more forceful, including a lowering of the unemployment threshold and/or the introduction of a lower threshold for inflation, below which a rate hike will not be considered,” says the Morgan Stanley economist.