The Federal Reserve is beginning the first phase of its very benign, very conditional, very cautious path of stimulus removal. Fed Chairman Jerome Powell, who has been nominated for a second term at the helm of the US central bank, intends to back down against any speculation about whether to talk about a rate hike.
But in the rest of the world, from Latin America to Eastern Europe, Africa and more recently some developed-market countries, something different is going on in the halls of central monetary authorities.
in the back January 2021 I tweeted half-jokingly, half-seriously that the 300 basis-point rate hike by the Bank of Mozambique was a “sign of things to come…”.
This was Mozambique’s first interest rate hike in four years, and came in response to described as a “substantial upward revision of its outlook for inflation” at the time.
Fast-forward 10 months. Without really planning it, I decided to add to that tweet – creating a live thread tracking the pivot of global policy from rate cuts to rate hikes. Since then I have seen rate increases, both large and small, by the central banks of Azerbaijan, Zambia, Brazil, Russia, Iceland, Angola, Sri Lanka, South Korea, Norway and New Zealand. In all, I have calculated 94 interest rate hikes across 36 central banks so far this year.
Now obviously if this was just a rate hike by a central bank, or even a handful of people, it might not even have been mentioned. But when you start talking about these kinds of numbers, it’s hard not to notice the pattern. In that regard, the chart below does a good job of properly mapping out that pattern:
It reflects the proportion of central banks in rate-growth mode (defined as the increase in the final interest rate). Fully two-thirds of emerging market central banks are now in rate-hike mode, after falling to zero in early 2020.
Why climb now?
There are some common themes as to why countries around the world are raising rates, including inflation, currency, and financial stability. let’s take a closer look:
Inflation: We were quickly talking to some people about inflation at the beginning of the year, inflation was probably the hot macro topic of the last few months.
The base effect (easier to record a higher pace of growth than a lower base), bounce back (reopening + stimulus = stronger demand), and backlog (supply-chain hell) combined to drive a sharp turnaround in both inflation and inflation expectations .
Emerging economies are particularly sensitive to inflation. In recent times, as a group, they have seen a tendency to see twice the annual rate of inflation that you would see in developed economies. Furthermore, you only need to go back more than 20 years to see hyperinflation in emerging economies (as a group they saw peak inflation of 115% in 1993, and double-digit inflation by 2000).
Think about your average emerging market central bank governor – many of them were junior economists probably 20 years ago. Undoubtedly his formative years were heavily influenced by runaway inflation. It’s no surprise that as inflation rises, they hot on the trigger for raising rates.
Posture: Many central banks have also raised rates in an effort to advance their currencies in the form of the US dollar (DXY).
strengthens. The line of reasoning here is two-fold: higher inflation (all else being equal) means a fundamentally weaker currency, and higher interest rates entice traders looking for higher yields: bringing in inflow and outflow of the country’s currency. Raise a demand
financial stability: The word is originally a euphemism for “try not to blow bubbles”. In other words, if you keep rates too low for too long, you risk igniting asset-price bubbles, which can trigger financial instability if they burst in a chaotic fashion. Case in point: the housing bubble of the mid-2000s, its subsequent burst and the ensuing great financial crisis.
On that note, we should probably pay more attention to this aspect, as developed-economy housing market valuations have already passed pre-financial crisis highs.
Yes, that’s right: Ultra-low borrowing costs have helped propel the valuation of the housing market in some countries above pre-financial crisis levels. This is one reason why it is said that monetary policy is a blunt tool – it works roughly when it comes to surviving deep economic downturns and depressions, but the price is often high asset prices.
,Expect lower tailwinds for riskier assets, upward pressure on borrowing costs, and potentially more volatile markets going forward.,
The global policy pivot to rate hikes (with Canada and the UK likely to be joined soon) means investors can expect less of a tailwind for riskier assets, with upward pressure on borrowing costs, And one can expect more volatile markets going forward.
In fact, mapping out past trajectories in policy, the chart below shows how a shift to easing tightening best means a level-out or regime change in the market; For example from a near vertical line to more chopping and ranging. In the worst case, this policy change could trigger an outright shift from a bull market to a bear market, if held tight enough for a long period of time.
You might be wondering what all these random small, emerging market central banks raising interest rates have to do with the S&P500 SPX,
, You’ve probably heard the adage that when the Fed sneezes, the rest of the world catches a cold, but in that sense, the Fed is still likely to drag its feet on policy for some time, almost more so than the rest. Worldwide cold and US equities catch the sneeze.
You only need to go back to 2015-16, where a lot of volatility in US markets was driven by or triggered by issues in China and emerging markets, or the period after the financial crisis when the eurozone debt crisis was raging and weighing on There was global investor sentiment.
Beyond regional crises – which may stem from premature removal of stimulus – the larger issue is the general theme driving monetary policy.
While each central bank has its own set of circumstances, the general theme is a response to high inflation, strong growth and a desire to avoid overbought markets. It is the small/developing-country central banks that are most affected by these global trends, and so we can see them as bellwethers or leading indicators.
The forces driving the momentum in Mozambique are the same forces that will ultimately push the Fed to move away from stimulus.
It may take time, but one thing I know to be true is that these things go in cycles. While it looks and feels like the Fed has always had your back in the markets, that won’t always be true. “Don’t fight the feds” means swim with the tide, not against it, and the tides are clearly turning here.
more: What the Fed means for Americans’ bank accounts under the leadership of Powell and Brainard
Why it matters to you that Jerome Powell will serve another term as chairman of the Federal Reserve