Opinion: How a single rate hike by a tiny African country could derail Fed Powell’s anti-inflation plans and crash stocks

Return January In 2021, I tweeted half-jokingly, half-truth that a 300 basis point increase in interest rates by the Bank of Mozambique was a “Sign of things to come…”

This is Mozambique’s first interest rate hike in 4 years, and what response description at the time as a “significantly increased revision of the inflation outlook.”

Fast forward 10 months. Without really planning, I decided to add to that tweet – creating a live stream that tracks the global policy swing from rate cuts to rate hikes. Since then, I have recorded large and small rate increases by the central banks of Azerbaijan, Zambia, Brazil, Russia, Iceland, Angola, Sri Lanka, South Korea, Norway and New Zealand, to name a few. some. In total, I counted 94 rate hikes at 36 central banks so far this year.

Now it’s clear if this is just one central bank rate hike, or even a few, it might not even need mention. But when you start talking about these kinds of numbers, it’s hard not to notice a pattern. In that respect, the chart below does a good job of accurately mapping that model:

It shows the proportion of central banks that are in rate-raising mode (defined as the last interest rate move to increase). After falling to zero in early 2020, two-thirds of emerging market central banks have now moved into rate-raising mode.

Why increase now?

There are several general themes about why countries around the world raise rates, including inflation, currency, and financial stability. Let’s take a closer look:

Inflationary: We quickly went from little talk about inflation at the beginning of the year to what has been perhaps the hottest macro topic of the past few months.

Fundamentals (easier to note higher growth when compared to low fundamentals), backlash (reopening + stimulus = strong demand) and backlog (supply chain hell) response) combine to promote dramatic changes in both inflation and inflation expectations.

Emerging economies are particularly sensitive to inflation. In more recent times, as a group, they tend to see annual inflation rates twice the rates you’ll see in advanced economies. Furthermore, you only need to go back over 20 years to see hyperinflation in emerging economies (like a group that saw a peak of 115% in 1993 and double inflation). numbers until 2000).

Think of your average emerging-market central bank governor – many of them probably junior economists 20 years ago. Their formative years were certainly hit hard by runaway inflation. There is a little doubt that they are looking to raise interest rates when inflation heats up.

Currency: Many central banks have also raised interest rates in an attempt to push their currencies up like the US dollar
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consolidate. The line of reasoning here is twofold: higher inflation (all in all) means a weaker currency, and higher interest rates appeal to traders looking for higher yields: yield the flow and lift of demand for a country’s currency.

Financial stability: The term is basically a fancy way of saying “try not to pop a bubble.” In other words, if you keep rates too low for too long, you run the risk of triggering asset price bubbles, which if they burst in a chaotic fashion can cause financial instability. Case in point: the housing bubble of the mid-2000s, its subsequent boom and the ensuing Great Financial Crisis.

On that note, we should probably pay more attention to this aspect, as advanced-economy housing market valuations have passed their pre-financial crisis highs.

Yes, that’s right: Extremely low borrowing costs have helped push housing market valuations in some countries above pre-financial crisis levels. This is one reason why monetary policy is said to be a blunt instrument – it roughly does the job when it comes to avoiding recessions and deeper recessions, but the cost is often is the higher asset price.

Market impact

The global policy pivot to rate hikes (likely to be joined soon by Canada and the UK) means investors can expect less and less volatility in risk assets, pressure increasing borrowing costs and potentially more volatile markets in the future.

Indeed, delineating past lines in policy, the chart below shows how a shift from easing to tightening means a loss of balance or a regime change in the market; e.g. from a nearly vertical line to tighter and different. At worst, if tight enough for long enough, this policy change could trigger a complete shift from a bull market to a bear market.

You might be thinking, what does all this randomness that small, emerging market central banks, central banks raise rates have to do with the S&P500?
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? You may have heard the saying that when the Fed sneezes, the rest of the world catches a cold, but in this sense, given that the Fed is still likely to stretch its policy for a while, almost more the rest of the world caught a cold and the US stocks sneezed.

You just need to go back to 2015-16, where much of the volatility in US markets back then was driven or triggered by problems in China and emerging markets, or during post-financial crisis when the eurozone debt crisis was raging and weighing heavily. global investor sentiment.

Beyond the regional crises – possibly caused by the removal of early stimulus – the larger issue is the general themes driving monetary policy.

Although each central bank has its own unique circumstances, the common theme is a response to higher inflation, stronger growth, and a desire to avoid market overdevelopment. It is the smaller/developing central banks that are most exposed to these global trends, and so we can treat them as headliners or indicators.

The forces that are triggering the rate hikes in Mozambique are the same forces that will eventually lead the Fed to abandon stimulus.

It can take time, but one thing I do know is that these things happen in cycles. While it may seem like the Fed has your back in the market right now, that’s not always the case. “Don’t go against the Fed” means swim with the tide, not against it, and the tides here are clearly turning.

Callum Thomas is the founder and research team leader at Top-down chart, a global economic research and asset allocation firm.

Than: What the Fed led by Powell and Brainard means for Americans’ bank accounts

To add: Why It’s Important To You That Jerome Powell Will Serve Another Term As Federal Reserve Chair