Opinion: How an interest rate hike in a tiny African country could derail Powell’s policy plans and drop stocks


The Federal Reserve is entering the first phase of its very soft, very conditional and very cautious road to removing stimulus. Fed Chairman Jerome Powell, who has just been appointed for a second term as head of the US central bank, intends to reject any speculation on the idea of ​​talking about rate hikes.

But in the rest of the world, something quite different is happening in the corridors of central monetary authorities from Latin America to Eastern Europe, Africa and, lately, even some developed countries. .

Back January 2021 I wrote a half-joke, half-serious tweet, noting that the 300 basis point interest rate hike by the Bank of Mozambique was a “Sign of things to come …”

It was Mozambique’s first interest rate hike in four years, and came in response to what he described at the time as a “substantial upward revision to its inflation outlook.” .

Fast forward 10 months. Without really planning it, I decided to add to this tweet – creating a live thread on the pivot of global politics, from rate cuts to rate hikes. The central banks of Azerbaijan, Zambia, Brazil, Russia, Iceland, Angola, Sri Lanka, South Korea, Norway and New Zealand, to name a few , take note of interest rate increases large and small. In total, I have counted 94 interest rate hikes in 36 central banks so far this year.

Now, obviously, if this was just one rate hike by a central bank, or even a handful, it might not even be worth a mention. But when you start talking about numbers like these, it’s hard not to notice a pattern. In that regard, I think this graph does a good job of mapping this model accurately:

It shows the proportion of central banks in rate hike mode (defined as the last interest rate move being an increase). After falling to zero in early 2020, two-thirds of emerging market central banks have now entered rate hike mode.

Why hike now?

There are a few common themes as to why countries around the world are raising rates, including inflation, currency, and financial stability. Let’s take a closer look:

Inflation: We have quickly gone from very few people talking about inflation at the start of the year to inflation which may be the hot macro topic of recent months.

Base effects (easier to register a higher growth rate compared to a low base), rebounds (reopening + stimulus = strong demand) and delays (supply chain hell) have all been coming together. combined to bring about a sudden change in inflation and inflation expectations.

Emerging economies are particularly sensitive to inflation. In recent times, as a group, they have tended to see an annual rate of inflation twice as high as you would see in developed economies. Moreover, one only has to go back a little over 20 years to see hyperinflation in emerging economies (as a group they experienced an inflation spike of 115% in 1993 and double-digit inflation up to in 2000).

Think about your average emerging market central bank governor – a lot of them were probably junior economists 20 years ago. Their formative years were undoubtedly heavily influenced by soaring inflation. So it’s no wonder they are about to trigger a rate hike as inflation escalates.

Cash: Many central banks have also raised their rates in an attempt to support their currencies like the US dollar DXY,
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strengthens. The reasoning here is twofold: higher inflation (all other things being equal) means a fundamentally weaker currency, and higher interest rates attract carry traders looking to bank the highest returns: bring flows and increase demand for a country’s currency.

Financial stability: This term is essentially a euphemism for “try not to blow bubbles”. In other words, if you keep rates too low for too long, you risk triggering asset price bubbles which, if they burst chaotically, can trigger financial instability. Concrete example: the real estate bubble of the mid-2000s, its bursting and the Great Financial Crisis that followed.

On that note, we should probably pay more attention to this aspect as the real estate market valuations of developed economies have already surpassed pre-financial crisis highs.

Yes, it’s true: Ultra-low borrowing costs have helped push real estate market valuations in some countries well above pre-financial crisis levels. This is one of the reasons monetary policy is said to be a blunt tool – it pretty much does the job when it comes to avoiding deeper economic recessions and depressions, but the price is often higher asset prices.

Expect less tailwind for risky assets, upward pressure on borrowing costs, and possibly more volatile markets going forward.

Market impact

The pivot in global policy towards rate hikes (which will likely soon be joined by Canada and the UK) means that investors can expect less of a tailwind for risky assets, pressure to higher borrowing costs and possibly more volatile markets in the future.

Indeed, retracing previous political trajectories, the graph below shows how the shift from easing to tightening means at best a leveling or regime change in the market; eg from an almost vertical line to more hash and distance. At worst, if tight enough for long enough, this policy change can trigger an outright shift from a bull market to a bear market.

You might be wondering what all those random little emerging market central banks raising interest rates have to do with the S & P500 SPX,
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? You’ve probably heard the saying that when the Fed sneezes the rest of the world catches a cold, but in that sense, given that the Fed is still at risk of dragging its feet on policy for a while, it’s almost over. let the rest of the world catch a cold and US stocks sneeze.

Just go back to 2015-16, where much of the volatility in US markets at the time was due or triggered by problems in China and emerging markets, or during the post-financial crisis period when the eurozone debt raged and weighed down. sentiment of global investors.

But beyond regional crises – which can be precipitated by the premature removal of stimulus measures, the bigger problem lies in the common themes driving monetary policy.

While each country’s central bank has its own unique circumstances, the common theme is that they respond to higher inflation, stronger growth, and a desire to avoid overcooking the markets. It is the central banks of smaller / developing countries that are most exposed to these global trends, and therefore we can consider them as indicators or leading indicators.

The moving forces that triggered a rate hike in Mozambique are the same ones that will ultimately push the Fed away from the stimulus.

It might take a while, but one thing I know to be true is that these things go in cycles. Even though it looks like the Fed is backing you forever in the markets right now, that won’t always be true. “Don’t fight the Fed” means to swim with the tide, not against it, and the tides here are clearly turning.

Callum thomas is Founder and Head of Research at Topdown Charts, a global asset allocation and economics research firm.

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