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How accommodating are the central banks?

There has been a concerted downward move in interest rates by many central banks in recent months. Will this continue?

There has been a concerted downward move in interest rates by many central banks in recent months. Will this continue?

by
John Redwood

in Features

13.08.2019

The bond markets tell us interest rates are going to fall further. Many advanced country government bonds are now riding high, meaning they offer little or no income return to anyone who buys them. The bonds of emerging market economies are also joining in the bull market, around considerably higher interest rate levels.

There has been a concerted downward move in rates in recent months. The endless speculation that the US would lower its rates gave some space to countries keen to do so. Lower rates in the US is thought to lead to a softer dollar, which in turn gives emerging economies some relief from devaluations forced on them by tough US money policies and the resulting dollar surge. We have seen rate cuts in Turkey, Indonesia, Argentina, India, Thailand, Brazil, South Africa and other emerging economies. We have also seen cuts in Australia, New Zealand, South Korea and eventually in the US itself.

How low?

There are some doubts about how far the central bankers want to take these moves. In the US, a reluctant Fed was caught out by the markets at the end of last year. Keen on putting up rates to normalise against a background of a decent economic expansion, the Fed was told off by the President and warned brutally by the markets that it was tightening money too much and would damage the recovery. At the turn of the year the Fed took the pressure off by announcing it would be patient before putting rates up again. It has spent this year so far rethinking its approach to rate rises, and then putting through a 25-basis-point cut in its rates taking them down to 2-2.25%. Markets are probably expecting more rate cuts in the US than the Fed wants to make. We need to await the conclusions to the Fed’s rethink of policy, anticipating less than the market thinks likely.

At the core of this debate lie two rows President Trump is having. He wants the Fed to cut more, as he thinks the US could grow faster with more monetary loosening without undue inflationary problems. At the same time he is stepping up his economic war of words with China, imposing more tariffs and delaying a negotiated settlement of the trade dispute. This does reduce world trade modestly and hits confidence. It also gives the Fed a reason to move policy a bit more in the President’s direction as an offset for the trade deterioration. The issue of Fed independence is interwoven with this dispute.

Change of governors

It is not just in the US where the elected government wants an easier money policy than the central bank wishes to grant. In the cases of India and Turkey, the governments have changed central bank Governors to get an easier policy to promote more growth. New Governor Das has cut Indian rates a further 35 basis points to 5.4% recently. They were at 6.5% last year. New Governor Murat Uysal in Turkey has slashed the interest rate from 24% to 19.75%, with more cuts likely. Elsewhere, the central banks are largely moving in the direction governments want anyway. The cuts in Australia, New Zealand, South Korea and Brazil were undertaken by banks looking at weak data but also doubtless sensitive to government wishes to see some easing.

Big banks matter

It is the large economies and central banks that have most impact on investment markets. The European Central Bank has indicated that it might lower rates further and might start up a bond-buying programme again, despite having negative deposit rates and negative bond rates for several of the main issuers already. The Japanese Central Bank has also said it would consider taking its benchmark rate more negative and increasing its bond-buying programmes if that is needed to offer further stimulus to the economy. The Fed is agonising over whether to cut again as markets wish. The Chinese authorities have been walking a difficult tightrope between wanting to tidy up overstretched commercial banks with bad loans to the old economy, whilst at the same time extending enough credit to the new economy to keep growth at the official 6.5%. They may need to do more relaxing to achieve the growth they want. The central bank there is fully integrated with government policy.

It seems likely the central banks collectively will ease more this year. It is also possible that the Fed will not ease as much as markets think, but this would be only because economic data in the US may continue to hold up better than many investors fear. Bonds are in danger of overdoing the enthusiasm about rate cuts, whilst offering little or nothing by way of running returns. A worldwide recession still looks unlikely, though manufacturing remains weak. The hit to the car industry in particular is worrying, whilst manufacturing generally is affected by the trade disputes that extend beyond US/China to include Iranian sanctions and the Pakistan/India flare up over Kashmir.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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