The latest rate cut announced at the end of October by the Turkish central bank, an unorthodox institution given the influence of Recep Tayyip Erdogan, marked a milestone in terms of monetary policy. The 200 basis point snip marked the 1,000th rate cut for central banks since the Lehman Brothers bankruptcy back in 2008, according to data collated by Bank of America Securities.
If we put this figure into perspective, it could be said, for example, that since the financial crisis, the world economy has seen a drop in interest rates every three days on the stock market. All this peppered with a massive purchase of assets by the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England, which have since gobbled up around 23 trillion dollars, mainly in public debt.
“Liquidity Supernova”
This “liquidity supernova” as Bank of America chief strategist Michael Hartnett calls this monetary phenomenon has had succulent side effects for the market. It is true that the evolution of the market capitalization accumulated by Apple, Amazon, Facebook, Microsoft, Netflix and Tesla has gone hand in hand with the liquidity injected by the Federal Reserve. Anyone who invested $ 100 in the S&P 500 in early 2009 would have about $ 665.76 in early 2021, if they had reinvested all the dividends. This represents a return on investment of 565.76%, or 16.14% per year.
We must not overlook how the US central bank has multiplied by eight the size of its balance sheet to reach 8.5 trillion dollars at the end of October 27. However, with the underlying CPI on this side of the Atlantic currently standing at 4% year-on-year (the average of the last 10 years is 2%) Hartnett clarifies that “central banks are going to move from quantitative easing [QE, por sus siglas en inglés] looking for inflation to a tightening against rising prices “.
Although it is true that the central banks of the main advanced economies (G7) have not yet withdrawn their stimuli or instigated a rise in money (with exceptions such as Norway), rates are already rising rapidly among some emerging countries, according to Yasunari Ueno, chief market economist at Mizuho Securities.
The central bank of Brazil announced a rise of 150 basis points on October 27, bringing its reference Selic rate to 7.75%, and indicated that more are coming, with its Committee anticipating an adjustment of the same magnitude “for its Next meeting”. Other Latin American central banks have also already tightened their monetary policy. The logic is clear. Even if the global inflation drive is inherently transitory, the transmission mechanism is important. In economies with a long history of high and volatile inflation, inflation expectations cannot be relied upon to remain anchored.
The accumulated interest rates of the G7 remain stable at 0.375%
“Rising commodity prices also pose stagflation risks for these economies,” said Robert Rosener, an economist at Morgan Stanley. For commodity importers whose demand is quite inelastic, the effect is essentially a tax, which reduces purchasing power. This blow to the economy could lead to a depreciation of the currency, further reinforcing inflationary pressures. With the market already bracing for the start of this week’s Fed tapering and the experience of the 2013 tantrum in mind, currency-driven inflation looks all too real.
Similar dynamics are observed in other emerging markets. The Russian central bank had already announced on October 22 a rate hike of 75 basis points, taking its reference rate to 7.50%. It also “keeps open the prospect of further hikes in key rates in its next meetings.” For its part, the Reserve Bank of India did not change its interest rate on the 8th, but Lesetja Kganyago, governor of the Reserve Bank of South Africa, indicated that it could raise rates when it meets in November. The accumulated interest rate of the central banks of the BRICS (Brazil, Russia, India, China and South Africa) stood at 27.10% on October 28, above the pre-pandemic level of 26% at the end of February 2020 .
“The cumulative G7 rate remains stable at 0.375%, although it seems increasingly likely that the Bank of England will raise rates before the end of 2021 and the Bank of Canada voted on October 27 to end quantitative easing and he anticipated that the conditions will allow him to raise the rates “at some point in the central quarters of 2022”, reveals Ueno.
As of today, the consensus sees the Bank of England likely to raise rates as early as this month. For its part, the Canadian economy has recovered well and inflationary pressures are increasing. Furthermore, with the Fed moving towards tapering and markets already pricing in the first rate hike on this side of the Atlantic as early as June 2022, the Bank of Canada is preparing to act accordingly.
Fed Chairman Jerome Powell and the rest of the officials of the Federal Open Markets Committee (FOMC) have telegraphed to the market their roadmap to begin with the withdrawal of stimuli quite effectively. At this time, everything indicates that the monthly reductions of 10 billion dollars a month in Treasury securities and 5 billion dollars a month of assets backed by mortgages will be the correct formula that will allow the completion of the purchase program in the middle of next year. By then the market was already seeing a rise in rates.
Lagarde celebrates two years at the head of the ECB in no hurry to raise rates from 0%
“Two years ago, I began my term as President of the ECB. It has been very different than I expected! The pandemic has been a challenge like no other and I am pleased to say that the euro area economy is now firmly in mode recovery “. With these words Christine Lagarde began a message on LinkedIn yesterday in which she remembered the anniversary of her first two years at the head of the European Central Bank. Lagarde assumed his mandate with interest rates already at 0%, the level at which his predecessor, Mario Draghi, placed them in March 2016. Therefore, cutting rates has not been among the tools at his disposal.
He has used others such as the ‘QE’, the ‘TLTRO’ or the emergency program ‘PEPP’. Last week Lagarde acknowledged that economic momentum has moderated due to supply shortages and that inflation will continue to rise in the short term, although he expects some relief throughout 2022 and insisted on its transitory nature. He also warned that the ECB’s roadmap does not have to be the same as the one expected by the markets, hinting that rates will remain low for a long time in the euro zone.
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