Analysis: As Fed Looms, Global Central Banks Consider Their Own Exit From Stimulus
Haunted by memories of previous U.S. interest rate hikes, global central banks are paving the way for a transition to a life with less global stimulus, with many countries already signaling moves toward the exit.
As the Federal Reserve has publicly pledged to keep interest rates close to zero – and no hikes are expected until the end of next year at the earliest – official comments on inflationary pressures could become a chorus in the coming months, making downsizing a more concrete prospect and likely increasing volatility in global financial markets.
For some developed economies, a return to pre-pandemic conditions means that the withdrawal of the central bank stimulus is already underway.
Meanwhile, more vulnerable central banks are strengthening their financial systems to avoid the kind of capital flight that plagued emerging markets during the 2013 ‘tantrum’ that was sparked by mere hints of a tightening of the market. Fed after years of super-easy politics deployed during the Global Financial Crisis.
“There is a huge divergence between the economies emerging from the pandemic and those that are lagging behind. Some emerging central banks may be forced to raise rates to defend their currencies, even at the cost of harming their still fragile economies,” said Takahide Kiuchi, a former board member of the Bank of Japan (BOJ).
“This trend could broaden if the Fed communicates its reduction strategy in the coming months. This could be part of the risks to the global economy,” said Kiuchi, currently an economist at the Nomura Research Institute.
The Fed has said it will not start cutting its massive stimulus measures until there is “further substantial progress” in healing the US labor market.
While the job recovery remains uneven, higher than expected inflation raises the possibility that the Fed will have to tighten policy sooner than expected.
For now, markets are bracing for the chance that the Fed will start communicating its reduction strategy at its Jackson Hole symposium in August, with possible action later in the year.
Some central banks are already responding.
In April, Canada’s central bank became the first of the Group of Seven nations to withdraw its stimulus measures during a pandemic, and reported rates could start rising in 2022.
The Norwegian central bank has already announced its intention to hike rates in the third or fourth quarter of 2021.
New Zealand and South Korea have also hinted that tightening policies are on the agenda as conditions improve.
While decisions in these countries would be primarily driven by domestic considerations, the eventual withdrawal of Fed support appears to be a significant global risk for every central bank.
Even Japan’s central bank, which has barely budged from its ultra-accommodative parameters during decades of global cycles, could see an opportunity to cut stimulus.
“A Fed rate hike could give the BOJ an ideal opportunity to normalize its policy, without worrying too much about triggering a yen spike,” said Kiuchi of Nomura.
Developing economies face the greatest risks from the Fed tightening, which has in the past caused market gyrations as rising US interest rates have drawn funds into dollar assets and diverted them from emerging markets , as happened in 1998 and 2013.
Asian markets, the epicenter of the 1998 Asian financial crisis, remain in much better shape with strong foreign exchange reserves to support any currency rout.
The governor of India’s central bank said last week that its reserves now exceed $ 600 billion, which he says will help tackle the challenges of the “global fallout”.
But some analysts warn that lessons from the Asian financial crisis may not apply to the current shock induced by the pandemic.
“This crisis is unlike any other in that it is not a financial crisis or an economic crisis,” said former BOJ chief Nobuyasu Atago, who is now an economist at Ichiyoshi Securities in Japan.
“The inequality of the current global economy creates various risks for emerging economies.”
Among the countries that view the Fed with suspicion is Indonesia, which relies on foreign inflows to finance its current account deficit.
“Next year we need to prepare for the possibilities of the US central bank, the Fed, to change its monetary policy, thereby reducing its intervention on liquidity,” the governor of the Bank of Indonesia said last month, Perry Warjiyo, adding that such changes in US policy would likely impact local bond yields.
Central banks in the most vulnerable emerging markets, such as Brazil, Ghana and Armenia, have already started their tightening cycle in the face of mounting inflationary pressures.
Russia’s central bank is expected to hike rates on Friday for the third time in a row with inflation well above its target, according to a Reuters poll.
Turkey led the pack and aggressively toughened last year, a move the central bank governor hopes will serve as a “shield” against any Fed pivot.
But heavy external debt keeps Turkey vulnerable to Fed reduction talks. Rising US yields recently helped push the pound to all-time lows, delaying expected rate cuts.
For now, policymakers in countries like Thailand, the Philippines and South Africa believe the Fed will not increase prematurely and are confident that its communication with the markets will be transparent.
But they recognize the risks.
“The Fed has said it would like to see more inflation in the United States, it has indicated it will have some tolerance for inflation,” the bank’s deputy governor told Reuters South African reserve, Fundi Tshazibana.
“What we don’t all know is what this tolerance band is.”
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