In April, former US Treasury Secretary Larry Summers drew laughs from investors when he said the Fed’s next move might be tightening, not easing. In other words, Mr. Summers is predicting another rate hike, which could cause the markets to… explode.
And the truth is that few traders are still laughing. Of course, the likelihood of another hike remains low, but expectations from Asia were that the Fed would make five to six interest rate cuts in 2024. Such bets were expected to backfire, as inflation in the US remains stubbornly high: the April increased 3.4% on an annual basis.
Therefore, while it is well below the 9.1% where it hovered in mid-2022, it is still far from the Fed’s 2% target.
Persistently high inflation is weighing on American households.
For example, there are earnings lags at companies ranging from McDonald’s Corp to AutoZone Inc. There is a change in consumer attitudes. Inflation is not just nominal. It is cumulative, so everything is more expensive. The consumer, the average citizen, feels this.
The Fed, however, won’t see this momentum as a reason to cut borrowing costs significantly — at least not this year. Stagnation is a vital risk as oil prices rise amid growing unrest in the Middle East. The risk is heightened if the US Congress does not act boldly to increase productivity and competitiveness.
Asia
With the repricing of Fed rate cuts and a stronger dollar, Asian central banks will look to maintain some interest rate spread. Otherwise they risk weaker currencies and higher imported inflation. The dollar, another asset that Asia believed would weaken in 2024. As Powell extends the “higher for longer” era for yields, international capital is flocking to the US.
This dynamic is depriving Asian economies of the capital they need to prop up bond and equity markets. Underperforming Asian currencies bear the brunt of the [US monetary policy] repricing as investors “focus on the relative level of interest rates.
- Last month, Indonesia’s central bank announced a surprise rate hike of 25 basis points to support the rupiah’s slide, raising the benchmark rate to 6.25 percent.
- Meanwhile, Malaysia’s ringgit recently hit a 26-year low, returning to levels not seen since the 1997-98 Asian financial crisis.
- In Manila and Bangkok, policymakers are reviewing plans to cut interest rates, lest the Philippine peso and Thai baht fall, raising risks of capital flight.
- In Seoul, another nation hit hard by the previous Asian financial crisis, Bank of Korea Governor Rhee Chang-yong is warning against excessive speculation and is ready to “implement stabilization measures.”
The dollar will continue to move higher as more traders come to terms with the idea that the Fed will keep interest rates steady.
Central banks
It is pointed out that central banks in the United Kingdom, the Eurozone and Canada are likely to cut interest rates next month.
European Central Bank President Christine Lagarde noted that a cut is likely as pressures on consumer prices ease. This is likely to extend gains for the dollar, which has risen significantly in all 10 major industrialized nations. It has already risen 11% against the Japanese yen and 2% against the euro so far this year.
The process is sure to keep Asia on edge. Where the macroeconomic and potential policy divergence has been most evident, policymakers are closely watching the Fed’s moves to limit the extent of monetary volatility. However, keeping Fed rates higher than Asia thought on January 1 is a significant blow.
An example is the governor of the People’s Bank of China, Pan Gongsheng, who has hinted at interest rate cuts in recent months. Although China’s gross domestic product grew 5.3% in the first three months of 2024, retail sales and consumer confidence remain weak amid a deepening property crisis.
However, the PBOC’s room to cut rates depends more on what Fed officials do in Washington than on economic conditions in Beijing. Pan’s team appears to understand that an extension of the era of “longer maturity” yields will make it harder to cut interest rates without significantly weakening the currency against the dollar. And there are myriad reasons why the PBOC is reluctant to let the yuan weaken much.
- First, it could make it harder for property development giants to keep up with offshore bond payments, raising default risks.
- Second, it could squander the progress made in global confidence in the yuan.
- Third, it could make China another flash point in the US ahead of the November 5 election, if that’s possible.
In the meantime, President Xi is stepping up efforts to buy back the stock of unsold homes to stabilize the real estate sector. However, the Asian region remains too export-oriented and dollar-centric. Therefore, depending on exports, it still affects the exchange rate of the dollar.
For that matter, currency trends from Seoul to Jakarta smack of déjà vu for many global investors. A major cause of the Asian crisis of 1997-98 was the dollar, which attracted huge waves of capital from all directions. In 2024, this dynamic could wreak new havoc as the world’s largest economy defies predictions of a recession.
The Fed’s reluctance to ease, meanwhile, is widening the gap in interest rate differentials, putting fresh pressure on Asian central banks – making them unable to rein in their sovereign debt. At the same time, the American debt, which is approaching 35 trillion dollars, is a pre-election issue in the USA, clashing with the toxic electoral politics in Washington. Part of that risk stems from the extreme political polarization that jeopardizes Washington’s creditworthiness.
Last August, when Fitch Ratings cut America’s AAA credit score, it cited among the reasons the polarization behind the January 6, 2021 uprising.
Mercantile axis
Another concern is Washington’s sharp mercantilist pivot, starting in 2017. Then-President Trump imposed massive tariffs on Chinese goods. Biden also followed the policy of restrictions. Now, as Trump threatens 60% tariffs on all Chinese goods, while Biden tries to outdo him by imposing a 100% tax on Chinese electric vehicles.
This trade tax arms race is prompting retaliation from the Xi government, including tariffs of up to 25% on imported cars.
These policies are more likely to hurt than help the lower- and middle-income Americans they claim to benefit.
Most economists consider tariffs a bad idea because they prevent a country from reaping the benefits of specialization, disrupt the flow of goods and services, and lead to a misallocation of resources. Consumers and producers often pay higher prices when tariffs are applied. This could mean less US demand for Asian products.
Asia is also worried about a Fed error. Although the Fed did not cause the conditions that led to the Lehman Brothers crisis in 2008, its misreading of deep tensions in credit markets in 2007 compounded the carnage. By the time the debt markets started to dominate, it was too late for rate cuts to limit the financial chaos.
