The world’s most aggressive and synchronised monetary policy tightening in 40 years is entering a new phase as central banks prepare to slow the pace of interest-rate increases and break ranks over how much further they’ll go.
The shift toward a softer, less uniform rate-hiking campaign partly reflects growing disparities in a global economy still struggling with the aftershocks of the pandemic and Russia’s invasion of Ukraine. Another explanation is that debt burdens leave some economies more sensitive than others to tighter credit.
US growth remains resilient for now in the face of repeated rate increases by the Federal Reserve, which last week signaled it will likely raise rates to a higher peak than previously expected albeit perhaps at smaller increments. Many on Wall Street see the key US rate topping 5% next year.
By contrast, the UK, Australia and Canada, are already pulling back or indicating they won’t be as punchy in coming months amid concern following the Fed could plunge their economies into recessions.
A swing away from what TS Lombard economist Dario Perkins calls “peak monetary synchronisation” won’t be without problems.
This year’s Fed-driven surge of the dollar is already wreaking havoc among heavily-indebted developing countries and advanced nations dependent on energy and other imports priced in the US currency.
“Things could get even messier” if US policy makers push ahead with more rate increases, and central bankers with weaker economies decide against matching them, Perkins wrote in a report to clients last week.
The developing divergence was on full display last week. While both the Fed and the Bank of England raised interest rates by 75 basis points, their respective leaders struck different tones about what lies ahead.
Fed Chairman Jerome Powell emphasized that the central bank had “a ways to go” before it was finished raising rates even as he opened the door to a smaller increase in December. The US benchmark is now 3.75% to 4%.
Bank of England Governor Andrew Bailey, for his part, pushed back against market expectations for the scale of future increases amid fears such a path will deepen a recession that is all but guaranteed.
The dollar rose initially after Powell’s remarks while the British pound sank after Bailey’s.
Bond markets have been roiled over the past six months as investors buoyed by hopes a Fed pivot would lead to an easier international policy landscape suffered serial disappointment.
That’s sent the Bloomberg global bond index to an unprecedented year-to-date loss of about 20%.
For much of the past year, central banks were engaged in what Bank of America Corp. economist Ethan Harris labeled “a competition to see who can hike faster.”
That made sense given inflation had wrong-footed them by racing to decade-high levels with rates historically low.
But now the situation is changing even with inflation still way above targets in most places.
Borrowing costs are significantly higher and beginning to take a bite out of growth or labor markets.
Some economies are also more sensitive than others to rising rates because of household and business debts or housing markets which are stretched or driven by variable rate mortgages. Among them, according to Perkins: The UK, Canada, Australia, New Zealand and Norway.
“These economies will suffer recession long before the Fed has caused a US economic downturn,” he said.
So it shouldn’t be a surprise that monetary policymakers in some of these countries already have paused or reduced the size of their rate moves.
A general pullback in aggressiveness still points to “the end of the beginning” of the rate-hiking campaign, according to Gilles Moec, chief economist of AXA SA.
A Credit Suisse Group AG index shows dovish central bank surprises recently began outnumbering hawkish ones.
But hawks say that for all the talk of pivots, the peak in global rates has yet to be reached and may not be until the end of the first quarter of next year or even longer if inflation doesn’t fade.
Bloomberg Economics sees its global central bank rate reaching 5.5% in the middle of next year, up from 2.9% at the end of 2021. In advanced economies alone, a jump to 3.5% from 0.1% is anticipated.
Like the Fed, the European Central Bank may stay on the front foot with inflation north of 10%. “Our job is far from being completed,” President Christine Lagarde said last week, noting rates will need to enter restrictive territory to depress prices.
Aggregate global inflation is running at 9%, almost five times the 2% most central banks view as price stability, according to Citigroup Inc. economists, who see a 50% probability of a global recession next year.
Markets are now betting on a slower pace of tightening, but a higher end point. The average cash rate across advanced economies has jumped by almost 2 percentage points in 2022 and investors see that average climbing by about another percentage point in the coming months.
The Fed benchmark in a year’s time is expected to be 2.5 percentage points above the average across other major advanced economies, the widest gap since at least 2004. That premium is part of the reason ICE’s Dollar Index has soared this year to head for a record annual gain
“The Fed keeps promising more and the dollar keeps rising,” said Harris, who is head of global economics research for Bank of America.
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