A day before the Jackson Hole symposium, the Fed released the minutes of its latest Federal Open Market Committee meeting, which left US interest rates unchanged at 5.25-5.5 per cent. It said the “outlook for growth in the second half of 2024 had been marked down largely in response to weaker-than-expected labour market indicators”.
But the “vast majority” of the committee also felt that if “data continued to come in about as expected, it would likely be appropriate to ease policy at the next meeting”.
This has set up expectations of an interest-rate cut this month or next, with one more later in the year. US stock market investors are waiting for these announcements to guide stock prices higher. But beyond that, importantly, US rate cuts also bring prospects of a global economic reflation.
European Central Bank president Christine Lagarde, Bank of Japan governor Kazuo Ueda and US Fed chairman Jerome Powell at the Jackson Hole economic symposium in Moran, Wyoming, US, on August 25, 2023. Photo: Bloomberg
While the US held rates steady last month, Japan announced an increase to 0.25 per cent, up from a range of 0-0.1 per cent. It was the biggest jump in 17 years and signalled the Bank of Japan’s determination to fight deflation. This was in response to Japan’s real interest rates falling to “their most negative levels in the past 25 years”, according to a summary of opinions of the monetary policy meeting.
In the past, with the yen earning near-zero interest, it made sense to borrow yen and invest in currencies with a higher interest rate to earn a “carry” interest differential. Now, this “carry trade” is unwinding and the yen is strengthening against the dollar, from as weak as over 161 yen per dollar last month to around 145 yen now.
After decades of near-zero rates, Japan is by far the largest holder of Treasuries, with over US$1 trillion worth of the US government paper, contributing to a staggering net international investment position of over US$3.2 trillion at the end of March.
But as Japan’s interest rates normalise, and with US rates expected to fall, Japanese investors will find US bonds less attractive and will return to yen bonds. The narrowing interest rate differentials between the dollar, yen and euro will also ease pressure on the dollar to rise.
Rising US interest rates have a contractionary effect on the global economy, especially as developing economies have an outsize dollar-denominated debt. Now that US rates are set to fall, prospects in emerging markets are brightening. The Malaysian ringgit, for example, recently emerged as Asia’s best-performing currency against the US dollar, strengthening to 4.36 ringgit to the dollar, from a peak of 4.79 in April.
Not so long ago, market fears were for a world economy heading towards a recession in the medium term due to various structural weaknesses, a rise in trade protectionism, global warming and geopolitical tensions. Today, the world is merely muddling through as real interest rates decline.
Given the “exorbitant privilege” of the US dollar as the world’s major medium of exchange and store of value, the Federal Reserve is in fact indirectly responsible for global monetary conditions. Its cutting of US interest rates would, therefore, help to have a reflation effect on global liquidity.
At the same time, Japan’s return to a more normal monetary policy will boost the undervalued yen and, in effect, help weaken a dollar tending towards excessive strength.
The euro, however, faces a different set of challenges. Europe is slowing waking up to the reality that a prolonged war in Ukraine is not to its advantage. It needs to revive its trade competitiveness in the face of the huge threat from China’s manufacturing prowess, particularly in electric vehicles. The Chinese economy, meanwhile, is facing both a structural drag from the property sector and the challenges of an ageing population.
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Chinese EV maker BYD launches its first Southeast Asia factory in Thailand
Chinese EV maker BYD launches its first Southeast Asia factory in Thailand
All in all, those who view the world as a glass half full, like myself, see better days ahead for emerging markets, as lower US interest rates will mean a reversal of flows back to these markets.
Southeast Asia is poised for a round of economic stimulus, as incoming leaders in Indonesia and Thailand push for economic growth. Indonesia President-elect Prabowo Subianto has declared a wish to see 8 per cent gross domestic product growth, whereas Thailand’s Thaksin Shinawatra, the dominant force in the ruling Pheu Thai party, will clearly desire economic revival as part of his ambitions.
The coming days will be a roller-coaster ride. Predicting the future is a hard business.
Andrew Sheng comments on global affairs from an Asian perspective
