The Federal Reserve is embarking on the first stage of its very soft, very conditional, very cautious path to the removal of the stimulus. Fed Chair Jerome Powell, just nominated for a second term at the helm of the US central bank, plans to curb any speculation about rate hikes.
But in the rest of the world, something very different is going on in the halls of central monetary authorities, from Latin America to Eastern Europe, Africa and lately even in some developed markets.
Back in January 2021 I wrote a half-joke, half serious tweet, noting that the Bank of Mozambique’s 300bp rate hike was a “sign of things to come…”.
It was Mozambique’s first rate hike in four years and was in response to what it described at the time as a “substantial upward revision of the inflation outlook”.
Fast forward 10 months. Without really planning it, I decided to add to that tweet – create a live thread following the global policy spin, from rate cuts to rate hikes. Since then, I’ve noticed both major and minor rate hikes by the central banks of Azerbaijan, Zambia, Brazil, Russia, Iceland, Angola, Sri Lanka, South Korea, Norway, and New Zealand, to name a few. So far this year I have counted 94 rate hikes at 36 central banks.
Obviously, if this was just one rate hike by one central bank, or even a handful, it might not even warrant a mention. But when you start talking about numbers like this, it’s hard not to notice a pattern. In that regard, the chart below does a good job of charting that pattern exactly:
It shows the stock of central banks in rate hike mode (defined as the last rate move that is an increase). After falling to zero in early 2020, more than two-thirds of emerging market central banks have now switched to rate hikes.
Why walk now?
There are a few common themes as to why countries around the world are raising rates, including inflation, currency and financial stability. Let’s take a closer look at that:
Inflation: We moved quickly from few people talking about inflation at the start of the year to inflation, arguably the hot macro topic of recent months.
Base effects (easier to register a higher rate of growth compared to a low base), rebound (re-opening + stimulus = strong demand) and lagging (entire supply chain) together drove a sharp shift in both inflation and inflation expectations.
Emerging economies are particularly sensitive to inflation. Lately, as a group, they have tended to see annual inflation twice that of developed economies. Plus, you only have to go back a little over 20 years to see hyperinflation in emerging economies (as a group, they saw peak inflation of 115% in 1993 and double-digit inflation through 2000).
Think of the average central bank governor of emerging markets—many of whom were probably junior economists twenty years ago. Their early years were undoubtedly heavily influenced by runaway inflation. No wonder they are also busy raising interest rates as inflation picks up.
Currency: Many central banks have also raised rates in an effort to support their currencies as the US dollar DXY,
strengthens. The reasoning here is twofold: higher inflation (all else equal) means a fundamentally weaker currency, and higher interest rates are attractive to traders seeking higher returns: bringing flows and increasing demand for a country’s currency.
Financial stability: This term is actually a euphemism for “don’t try to blow bubbles”. In other words, if you keep interest rates too low for too long, you risk igniting asset price bubbles, which, if they burst in a chaotic manner, could lead to financial instability. Example: the housing bubble of the mid-2000s, its subsequent bursting and ensuing Great Financial Crisis.
In that regard, we should probably pay more attention to this aspect, as housing market valuations in the developed economy have already sailed past the pre-financial crisis peaks.
Yes, that’s right: ultra-low borrowing costs have helped housing market valuations in some countries soar well above pre-financial crisis levels. This is one of the reasons monetary policy is said to be a blunt instrument – it roughly does the job of avoiding deeper economic recessions and depressions, but the price is often higher asset prices.
“Expect less tailwinds for risky assets, upward pressure on borrowing costs and likely more volatile markets going forward.”
The global policy turn to rate hikes (and likely to include Canada and the UK soon) means investors can expect less tailwinds on risky assets, upward pressure on borrowing costs and likely more volatile markets in the future.
Indeed, by mapping the past paths in policy, the chart below shows how shifts from easing to tightening represent, at best, a leveling or regime shift in the market; for example from an almost vertical line to more chopping and varying. At worst, this policy change, if tight enough long enough, could trigger an outright shift from a bull market to a bear market.
You might be thinking, what do all these random little emerging market central banks raising interest rates have to do with the S&P500 SPX,
? You’ve probably heard the saying that when the Fed sneezes, the rest of the world catches a cold, but in that sense, since the Fed is likely to keep dragging its feet on policy for a while, it’s almost more that the rest of the world. world catches a cold and US stocks sneeze.
All you need to do is go back to 2015-16, where much of the volatility in US markets at the time was caused or caused by problems in China and emerging markets, or in the post-financial crisis period, when the debt crisis hit the US. eurozone raged and pressed on her. global investor sentiment.
Aside from regional crises – which could be accelerated by premature withdrawal of stimulus measures – the bigger problem is the common themes that motivate monetary policy.
While each central bank has its own set of circumstances, the common theme is a response to higher inflation, stronger growth and the desire to avoid over-boiling markets. It is the central banks of smaller/developing countries that are most exposed to these global trends, and so we can think of them as whistleblowers or leading indicators.
The forces in motion that have caused a rate hike in Mozambique are the same forces that will eventually push the Fed to forego stimulus.
It may take some time, but one thing I know to be true is that these things go in cycles. While it may seem and feel like the Fed is forever behind you in the markets right now, this won’t always be true. “Don’t fight the Fed” means swim with the tide, not against it, and the tide is clearly turning here.
Callum Thomas is founder and head of research at Topdown Charts, a global asset allocation and economics research firm.
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