After five years of pumping money into the U.S. and global economy, the Fed last week took another step toward normalizing monetary policy by trimming its purchases of Treasury bonds and mortgage-related debt by a further $10 billion to $65 billion a month and held out the prospect of similar reductions in coming months.
But the prospect of tighter liquidity, against the backdrop of an improving U.S. economy, has triggered major swings in global asset prices, including sharp falls in the currencies of many emerging markets that used to benefit from easy money seeking a high return.
The surprisingly sharp reaction of financial markets to a process that the Fed first flagged in May 2013 illustrates the unpredictable and tumultuous way that financial markets often re-price risks and force the hands of central banks.
Last week started off with the Reserve Bank of India (RBI) surprising markets by raising its policy rate by 25 basis points to 8.0 percent, making good on its promise from last month to act if there wasn’t a “significant reduction” in inflation.
Then the Central Bank of the Republic of Turkey (CBRT) shook off months of dithering and fine-tuning of its liquidity operations, by reverting to a simpler policy framework and raised its one-week repo rate by 550 basis points to 10 percent. While the CBRT was expected to raise rates, the size of the hikes surprised markets.
The South African Reserve Bank (SARB) delivered the third surprise of the week by raising its repo rate by 50 basis points to 5.5 percent in a move to head off future inflationary pressures from the declining rand.
The initial reaction of currency markets, fearing contagion and seeking safe haven, was to reject the three rate rises and any immediate benefit to the currencies of those three countries was soon lost.
But by the end of the week markets had settled down, with the result that India’s rupee ended 0.4 percent higher on the week against the U.S. dollar, Turkey’s embattled lira had risen 3.0 percent while South Africa’s rand was only marginally lower by 0.3 percent.
But market volatility was widespread and emerging market currencies were hit across-the-board as global investors treated them with one broad brush.
Russia’s rouble was hit and the central bank promised to intervene if the rouble strays outside its target corridor, Costa Rica’s central bank intervened to dampen the fall of its colon currency, Croatia’s central bank sold euros to ease pressure on its kuna currency and Romania’s central bank sold euros to support the leu .
As if investors’ nerves weren’t already frayed from sharp price swings, a spat over the lack of international policy cooperation erupted between the governor of India’s central bank and U.S. central bankers.
Raghuram Rajan, the governor of the RBI who has been applauded for his decisions since taking over the reins in September, said international monetary cooperation had broken down and appealed to the U.S. to take into account how its policies affect other nations.
But Rajan’s appeal fell on deaf ears, with Richard Fisher, the outspoken president of the Dallas Fed, rejecting the notion that the U.S. Fed should conduct its policy as if it were the world’s central bank because the Fed’s only mandate is to fulfill the mission that the U.S. Congress has set and other nations “have to figure out” how to deal with their own issues.
What makes this public tit-for-tat slightly unusual is that it involves central bankers, who normally cooperate in a collegial manner behind the scenes, rather than politicians, such as Brazil’s finance minister Guido Mantega, who coined the term of “currency wars” in 2010.
Rajan is hardly the first, nor will he be the last to object to the spillover effects on emerging markets from changes to U.S. monetary policy. But given his past as chief economist of the International Monetary Fund (IMF) and as professor of finance at the University of Chicago, Rajan’s criticism of the current U.S.-dominated international financial system carries weight and should be taken seriously.
Through the first five weeks of this year, policy rates worldwide have been raised four times as four of Morgan Stanley’s so-called “Fragile Five” (Brazil, Turkey, India and South Africa) have taken action. So far Indonesia, the fifth member of the group, has seen its rupiah hold up during the currency turmoil, possibly because it resolutely raised rates by 175 basis points last year.
Rate rises have accounted for 9.7 percent of this year’s 41 policy decisions by the 90 central banks followed by Central Bank News.
In contrast, policy rates have been cut five times, or 12.2 percent of this year’s policy decisions.
LIST OF LAST
WEEK’S CENTRAL BANK DECISIONS:
- Bangladesh holds rate, aims to reduce inflation to 7 pct
- Israel maintains rate on low inflation, moderate growth
- India raises rate 25 bps, does not expect further tightening
- Turkey hikes rates, to keep tight stance until CPI improves
- Malaysia holds rate steady, sees higher inflation
- South Africa raises rate 50 bps, says won’t hesitate to act
- Federal Reserve trims asset purchases by another $10 bln
- New Zealand holds rate, warns of higher rates “soon”
- Fiji holds rate, economy set to top 3% growth in 2014
- Moldova holds rate, balances risk of inflation vs deflation
- Angola holds rate but cuts reserve requirement to 12.5%
- Mexico holds rate, but keeps eye on inflationary pressures
- Zambia central bank leaves benchmark rate unchanged (Reuters)
- Colombia holds rate, sees inflation moving to target
- Trinidad & Tobago holds rate, sees no disruptive flows
| COUNTRY | MSCI | NEW RATE | OLD RATE | 1 YEAR AGO |
| BANGLADESH | FM | 7.75% | 7.75% | 7.75% |
| ISRAEL | DM | 1.00% | 1.00% | 1.75% |
| INDIA | EM | 8.00% | 7.75% | 7.75% |
| TURKEY | EM | 10.00% | 4.50% | 5.50% |
| UNITED STATES | DM | 0.25% | 0.25% | 0.25% |
| MALAYSIA | EM | 3.00% | 3.00% | 3.00% |
| SOUTH AFRICA | EM | 5.50% | 5.00% | 5.00% |
| NEW ZEALAND | DM | 2.50% | 2.50% | 2.50% |
| MOLDOVA | 3.50% | 3.50% | 4.50% | |
| FIJI | 0.50% | 0.50% | 0.50% | |
| ANGOLA | 9.25% | 9.25% | 10.00% | |
| MEXICO | EM | 3.50% | 3.50% | 4.50% |
| COLOMBIA | EM | 3.25% | 3.25% | 4.00% |
| TRINIDAD & TOBAGO | 2.75% | 2.75% | 2.75% | |
| ZAMBIA | 9.75% | 9.75% | 9.25% |
This week (Week 6) seven central banks will be deciding on monetary policy,
including Australia, Romania, Poland, the Philippines, the United Kingdom, the
Eurosystem (i.e. the European Central Bank) and the Czech Republic.
| COUNTRY | MSCI | DATE | CURRENT RATE | 1 YEAR AGO |
| AUSTRALIA | DM | 4-Feb | 2.50% | 3.00% |
| ROMANIA | FM | 4-Feb | 3.75% | 5.25% |
| POLAND | EM | 5-Feb | 2.50% | 3.75% |
| PHILIPPINES | EM | 6-Feb | 3.50% | 3.50% |
| UNITED KINGDOM | DM | 6-Feb | 0.50% | 0.50% |
| EUROSYSTEM | DM | 6-Feb | 0.25% | 0.75% |
| CZECH REPUBLIC | EM | 6-Feb | 0.05% | 0.05% |
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