Well, it is like the US Federal Reserve (FED) is the DJ at the global economic dance party, and all the other central banks are just trying to keep up with its funky monetary policy beats. They are out there on the dance floor, bobbing to the interest rate rhythm, desperately trying to stay in sync with the FED’s moves. It is a real financial boogie-down, and everyone’s hoping they will not trip over their own economic shoelaces!
The FED opted to keep the federal funds rate unchanged, again, between 5.25 and 5.50% on Wednesday the 20th of September 2023. The statement and rate decision by the FED was a carbon copy of the one made in July 2023 with FED chair Powell delivering hawkish remarks during his press conference. This further strengthened the FED’s “higher for longer” stance on interest rates. Central banks, including our SARB, each have independent mandates regarding their respective monetary policy decisions, but central banks are currently acting in lockstep with the FED. The FED is firmly in the driving seat, dictating global monetary policy with the current broad-based dollar strength keeping the FED’s hands firmly on the wheel.
The payoff matrix is fairly simple for central banks in this environment, it is a payoff between currency depreciation and local economic relief. The first option for a central bank is to jump the gun and start cutting interest rates, to stimulate local economic growth before the FED ends its hiking cycle. This may bring temporary economic relief for local consumers, but it will lead to rapid currency depreciation. This option is also too risky given that global inflation has not abated significantly.
The other option, and the option most central banks are taking, is to bite the bullet and follow the FED with their current contractive (hawkish) monetary policy. Given the SARB’s constitutional mandate to protect the value of the rand, they are taking option number two, so one would not necessarily expect interest rate relief from the SARB before the FED officially ends its hiking cycle.
Let us get back to the man behind the wheel, the FED. The FED’s latest dot plot forecast indicates that US short-term interest rates will remain high for the rest of the year as well as in 2024. The FED’s infamous dot plot is a chart that records each FED official’s projection for the central bank’s key short-term interest rate, the federal funds rate.
The dot plot which was published last week by the Federal Open Market Committee (FOMC) signalled that they see one more rate hike this year, a move that would bring the FED’s key rate to a new target range of 5.50 and 5.75%. The real shocker for the markets was the hawkish outlook for 2024 which sent the broad-based dollar index and US treasury yields flying to fresh highs while riskier assets such as equities tumbled.
The FED’s rate expectations for 2024 climbed from 4.625% to 5.125% following the latest dot plot chart while expectations for 2025 rose from 3.375% to 3.875%. It is thus clear, for now, that the FED is sticking to their higher for longer stance. The only thing, in our opinion, that will change their stance is if there is a significant liquidity shortage in the short-term lending markets, particularly in the US repo market as we saw with the repo market crisis in September 2019. Currently, the US banking sector is showing signs of fragility and the backstop as always is the FED, the lender and buyer of last resort.
Let us now turn our attention to the other major central banks, particularly the ones brave enough to jump the gun. The People Bank of China (PBoC) have recently turned to an expansionary monetary policy stance in an attempt to stimulate their local economy as well as patch the holes in their shadow banking system. The PBoC started cutting their loan prime rates back in June this year after they cut rates from 3.65% to 3.55%. They followed with another cut in August which places their loan prime rate at a rate of 3.45%. The stance has not been favourable to the Chinese Yuan as the currency has depreciated roughly 2.65% against the dollar since July this year. Year-to-date the Yuan has depreciated just under 10% against the dollar.
Another central bank that has remained, and always has been, dovish is the Bank of Japan (BoJ). The BoJ is the poster child of Modern Monetary Theory (MMT, or the Magic Money Theory). The BoJ has maintained near 0% interest rates which makes the Japanese Yen the world’s preferred carry trade currency. Additionally, the BoJ uses the MMT to suppress the yields on Japanese government bonds by buying up the bonds with freshly printed currency. This phenomenon is called yield curve control and the BoJ currently owns more than 50% of all Japanese government bonds.
Japan’s experiment with MMT over the years has failed to create growth and prosperity, in turn, it has largely caused economic stagnation. Japan currently has the highest national debt in the world with a debt-to-GDP ratio sitting at 234%. Consequently, the BoJ’s continued ultra-loose monetary stance in this environment has seen the Japanese Yen tumble roughly 16% against the dollar, year-to-date.
Touching base with the major Western central banks (Bank of England (BoE), European Central Bank (ECB), Bank of Canada and the Reserve Bank of Australia) there is not much to say to be honest. These central banks are strapped to the backseat, and they won’t step out of line regarding the FED’s plans for interest rate conditions.
Below you can visualise the interest rate moves by major developed central banks and how they all simply follow the leader, the FED, except for the Bank of Japan of course:
To close off the article we also included SA interest rates versus other emerging market central bank rates. The below graph provides some general insights into how South Africa’s repo rates compare to those of other emerging economies. Repo rates in emerging economies can vary widely based on factors such as inflation, economic stability, and central bank policies. South Africa’s repo rates are lower compared to other emerging economies.
Sources: WorldPopulationReview BIS
