Washington: Federal Reserve policymakers, already struggling to assure investors that they remain on track for a midyear interest rate rise, will find the task has just become harder with their peers in Europe and elsewhere headed in the opposite direction.
The swelling ranks of central banks cutting rates and ramping up stimulus make it more difficult and riskier for the Fed to proceed with plans to end crisis-era policies, according to Fed analysts and former staffers. It is not unusual for central banks to be out of synch at times, but the deepening divide between the Fed and much of the rest of the world is unprecedented, heightening the risks and uncertainty surrounding the Fed’s plans.
The European Central Bank’s (ECB’s) decision to pump €60 billion (Dh249 billion) a month into the faltering Eurozone economy just deepened the divide. The stimulus rivals the size of the quantitative easing programme the Fed ended only three months ago in a sign of confidence about US economic recovery.
The euro fell below $1.14 (Dh4.19) after the ECB announcement, its lowest level since July 2003, while interest rates on long-term US bonds continued their recent nosedive.
“The foreign outlook has darkened. And that will make this decision — lift off, the path of interest rates thereafter, how you communicate it — harder,” said Jon Faust, director of the Centre for Financial Economics at Johns Hopkins University in Baltimore. “It will be doubly important for the (Fed’s policy setting committee) to communicate how it is thinking about risks flowing from abroad, because we are facing a truly unique constellation of circumstances.” The Federal Open Market Committee meets this week, and is expected to repeat that those risks from abroad have yet to throw the US recovery or their rate plans off track.
US central bankers have been adamant on that point over the past several months despite tumbling oil prices, ebbing global growth, and market expectations that the Fed will eventually capitulate and delay its first rate increase since 2006.
US policymakers have insisted that as long as the economy continues generating jobs, growth will remain on track and inflation eventually would begin to rise towards the Fed’s 2 per cent target.
But this week will test whether, in fact, they are willing to swim against the current in conditions that get tougher by the week, and also if they can make their case convincingly. The ECB is not the only one pulling in the other direction.
The Bank of Japan and a host of important secondary players — Canada, India, Turkey, China, Denmark, and Switzerland among them — have cut interest rates recently, often surprising markets and showing how unpredictable conditions have become.
The steps those banks are taking will make the mechanics of raising US rates more challenging: lower rates and massive new liquidity overseas will lure investors to US assets as the higher-yielding safe haven of choice, pushing down the very rates the Fed will try to increase, and driving up the value of the dollar.
They could also hurt US jobs and growth, the indicators the Fed arguably cares most about. Fed officials have downplayed the dollar’s strength, noting that the US is less reliant on trade than other developed nations, and able to count more on domestic demand.
Yet the impact could be significant.
Bank of Canada’s surprise rate cut on Wednesday knocked down the Canadian dollar against the US currency below 81 cents, adding to a drop of 15 per cent since mid-2014. Canada is the US’s largest trading partner. It also shares supply chains in the auto and other industries that allow jobs and investment to shift to the cheapest source.
Other countries may follow along soon, driving up the value of the dollar further and making US goods more expensive. “The pressure on other commodity-dependent central banks to follow suit will likely rise in the coming months as they wipe the dust off their competitive devaluation playbook,” said TD Securities analyst Millan Mulraine.
