There are three kinds of policymakers at the Federal Reserve, goes the chatter in the markets: hawks, doves and chickens.
It was the third type of bird that was setting policy recently, when the US central bank decided to hold interest rates at their historic low. And while market pricing — as opposed to surveys of economists — had largely anticipated the decision, the Fed still surprised in the extent of its caution, citing China, global financial uncertainties and overly low domestic inflation as reasons to stand still.
Its lack of action will have the biggest impact on other developed country central banks that are also at the zero lower bound of monetary policy. With the euro once again gaining ground against the dollar, the European Central Bank could signal as soon as October that it will expand its quantitative easing programme — perhaps first by extending its end date beyond September 2016 and then by increasing monthly purchases.
The odds have also risen that the Bank of Japan will add to its current accommodation, though it is likely to take longer to decide. And surely the Bank of England, which was seen as the bank most likely to “follow the Fed” and raise rates in its wake, will now be able to hold off in the face of decidedly mixed economic data.
Emerging markets, meanwhile, can be roughly divided into three groups, reckons Medley Global Advisors, a macro research service owned by the FT: those where the Fed’s forbearance makes little difference, those where it is helpful and those where it only complicates policy.
As we were
China will continue to plough its own furrow. A weaker dollar might reduce the pace of capital outflows from the mainland and the scale of intervention by the People’s Bank of China, but not by much. While expectations of further yuan depreciation remain entrenched, outflows will continue and cuts in interest rates and reserve requirements will come in response to that.
Russia will also continue to cut rates, and as fast as falling domestic inflation allows, in order to support a rapidly shrinking economy. A weaker dollar is helpful but it is the oil price and the pass-through to inflation from previous rouble weakness that are critical.
Most of central and eastern Europe is also unaffected, but for much happier reasons. Economic growth in Poland, Hungary, the Czech Republic and Romania remains strong or at least decent; inflation remains low; and with rates already at record lows, the region’s central banks can afford to wait for a gradual strengthening of Eurozone and, hopefully, global growth.
With a little help from my friends
Fed forbearance, on the other hand, will come in very handy in some of the most fragile emerging economies. After raising rates faster and further than it ever intended, Brazil’s central bank declared itself to be on hold from late July. But it is already under renewed pressure to act as inflation climbs ever higher and the currency’s collapse to almost R$4 to the US dollar following the country’s downgrade to a junk credit rating. Steady US rates and a weaker greenback may be just enough to help the Bacen avoid inflicting further pain on Brazil’s recessionary economy.
Similarly, the longer the Fed delays hiking, the better for Turkey. Rates will have to rise at some point given poor inflation data, a weak currency and what looks like continuing political deadlock even after a second election in November. But growth is weak and the longer the central bank can avoid tightening, the more pleased its political masters will be.
South Africa, another of the original “fragile five” EMs, faces the same constraints. Activity is anaemic, the currency weak and domestic inflation too high — with the risk of further large wage settlements for miners driving it higher. In response, the Reserve Bank started normalising rates in July, but the more it can take its time, the less likely it is to push the economy into recession.
Mexico, while in a much stronger position, also has reason to thank the Fed. Because of its proximity to the US and the deep liquidity of its markets, which makes the peso more volatile than fundamentals justify, it was seen as another country bound to follow the Fed higher. Yet with domestic inflation at barely 2.5 per cent, its lowest level since the 1960s, there is absolutely no reason to do so domestically.
Some of Asia’s central banks are probably pleased as well — but for the opposite reason. They had anticipated a Fed hike this year and some, like Bank Indonesia, were indeed calling for their US peers to get on with it. But underneath they were concerned about the impact of further dollar strength on their currencies and what they might be forced to do — in terms of intervention and even monetary policy — to shore them up.
From a purely domestic standpoint, by contrast, they would prefer to stimulate spending by households and businesses and to compensate for slow public infrastructure investment. South Korea will very likely cut rates again before year end.
And if Fed lift-off is delayed into next year, then Malaysia, Indonesia and Thailand may feel free to ease as well.
Between the Fed and a hard place
Following several unexpectedly high inflation prints, investors were anticipating the start of a hiking cycle by Colombia’s central bank. But with Banrep’s board seemingly split between hawks and doves, it had so far held off.
Its Andean neighbour, Chile, opted to hold rates earlier in September and while its next move will also be an increase, delays in US tightening could prompt the Chileans to postpone the beginning of their cycle as well, especially if the peso now stays on an even keel. Meanwhile, Peru, which already started to hike to counter rapidly rising prices, will probably be forced to continue — but could look a little exposed over the next few months and a strengthening sol could damage exports.
If the Fed has only delayed lift-off by a month or three, then the effect on EM monetary policy will not be significant or long-lasting. But there are tactical difficulties to changing policy either at its meetings in October (no scheduled press conference and no new forecasts) and December (year-end liquidity issues).
Which is why markets are not fully pricing a rate rise until March 2016. If it stays on hold until then, that really would have implications for its peers, not least by signalling a lack of confidence in the global outlook. By year end, we will know which birds are really in charge.
— Financial Times
