Federal Reserve Tightening Imposing Strain on Global Economy
October 11, 2022
When Federal Reserve officials began to raise interest rates in mid-March of this year, they were already far behind the eight ball, especially since tightening began from an historically low federal funds target of zero to 0.25%. By the time of that belated reaction, U.S. inflation was at 7.9% and 6.3% measured by the consumer price index and personal consumption expenditure price deflator, respectively. Although current inflation is not far from those levels, the three percentage point cumulative rise in the Fed’s interest rate to date still leaves short-term interest rates deeply in negative territory and even more so than generally realized because it takes about a half year for a change in interest rates filters down to affecting the economy. From a U.S. economy standpoint, Fed officials have little alternative choice but to continue on a path of aggressive tightening, featuring relentless sizable rate hikes, reductions in the bloated Fed balance sheet, and very hawkish rhetoric.
From the standpoint of other industrialized economies and developing ones to an even greater extent, the imperative of progressive Fed tightening has already created a crisis. The burden of servicing dollar-denominated debt has ballooned, and dollar appreciation has been exporting U.S. inflation abroad, forcing other central banks to follow the Fed’s tightening lead. Long-term interest rates have risen sharply, not just in the United States. The 10-year German bund yield today is two full percentage points above its level when Fed tightening began, and the 10-year British Gilt yield has climbed 285 basis points.
This morning’s levels of U.S. and Italian 10-year sovereign debt yields are six and 12 basis points higher than yesterday’s. The weighted DXY dollar index is close to a 20-year high and 15% above its level when the Fed first tightened last March. In overnight action, the dollar climbed 0.6% against the Australian dollar and 0.3% relative to the Swiss franc and Chinese yuan but is unchanged against the yen and sterling and 0.1% softer versus the euro.
U.S. equities have softened further in futures trading and show drops since the first Fed tightening of 16% in the S&P 500 and 21% in the technology-intensive Nasdaq. Equity markets today in the Pacific Rim plunged 4.4% in Taiwan, 2.6% in Japan, 2.2% in Hong Kong, 1.8% in South Korea, 1.5% in India and 1.4% in Malaysia. They are down so far today in Europe by 1.1% in the U.K., 1.3% in Italy, and 0.9% in Italy and Germany.
Fear of coming recession in many parts of the global economy have been exacerbated by the unresolved Russian invasion of Ukraine. President Putin may not have achieved his initial military aims, but he can take some solace from the fact that his reckless foreign policy has wreaked havoc on western economies and confidence. As is to be expected, the gloom has weighed on commodity prices, with WTI oil, gold, and Bitcoin losing 2.3%, 0.3% and 0.2% so far today.
Some central banks have resorted to unconventional tools to counter the financial market fallout of Fed tightening and Putin’s war. The Bank of Japan purchased a record $19 billion equivalent of yen on a single day late in January. Whether that operation has been followed up by additional currency market intervention, the yen has not crossed beyond the 24-year low of 145.9 per dollar that provoked Japanese officials to act then, but it came very close in overnight trading. The Bank of England has increased its purchases of long-dated gilts to counter the rise of British long-term rates. The 10-year gilt overnight came within four basis points of matching the recent peak of 4.50% but has settled back to 4.1%. And sterling, which on September 26th revisited its 1985 all-time low of $1.0345, is now hovering around $1.10.
Data released in Japan today showed a bounce in the Economy Watchers current conditions index from 45.5 in August to a 3-month high of 48.4 last month, but the E-Watchers future conditions index slipped back to a 2-month low of 49.2. Japan also reported a greatly trimmed August JPY 59 billion current account surplus versus surpluses of JPY 229 billion in July and JPY 1.501 trillion in August 2021.
Small business sentiment in the United States improved to a 4-month high last month.
But Australia’s Westpac-MI index of consumer confidence printed lower in October at 83.7 after 84.4 in September and a one-year low of 81.2 in August. Officials said confidence remains in deeply pessimistic territory. The National Australia Bank’s monthly index of business confidence dropped five points to a 3-month low of +5 in September. On a better note, building permits in Australia rose for a third straight month in August and by more than in June or July.
Consumer prices in Hungary shot up 4.1% on month in September and lifted the 12-month rate of increase to a 310-month high of 20.1%. Hungarian CPI inflation in the year to September 2021 had been 5.5%. Likewise, Czech CPI inflation of 18.0% in September represented a 345-month high and was up from 4.9% a year earlier.
British labor market statistics were mixed. Jobless claims increased by a greater-than-forecast 25.5k in September, but the associated unemployment rate of 3.5% was the lowest since 1974. Accelerating wage growth of 6.0% overall and 5.4% excluding bonus pay in August also depicted labor market tightness, but employment over the past three reported months dropped 109k. A separate report of British same-store sales showed a third straight on-year advance, which at 1.8% in September exceeded expectations.
Industrial production in Italy far outperformed analysts forecasts in August, rising 2.3% from July and 2.9% from the same month a year earlier.
On-year growth in Chinese motor vehicle sales of 25.7% in September was down from August’s rise of 32.1% but not by as much as had been predicted.
On-year growth in Indonesian retail sales has slowed from 15.2% last January to 6.2% in July and 4.9% by August.
Turkey’s current account deficit of $39.1 billion in January-August was three times greater than the deficit in the first eight months of 2021.
The Filipino trade deficit widened from $24.8 billion in the first eight months of 2021 to $41.8 billion in January-August of 2022.
A 2.1% rise in South African factory output in August was the most in seven months, but the 12-month rate of increase slowed to 1.4%.
Copyright 2022, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
Tags: Fed policy and the global economy, Japan current account, U.S. small business sentiment