The global central bank balancing act

PERSPECTIVE

The global central bank balancing act. After record interest rate rises from central banks around the world, inflationary pressures appear to have peaked. The primary role of central banks is to ensure price stability in their respective economies while ensuring this does not come at the cost of rampant unemployment and negative growth. With inflation either remaining steady or falling back toward target ranges the focus now shifts to the danger of over-tightening. Recieved wisdom is that interest rate hikes take between 12-18 months to show their full effect on economies. Due to the pace of some central bank hikes (particularly the FED), not enough time has passed to know if they went too far, and there is certainly more caution leading into the next round of monetary policy meetings. This week we have what is expected to be another strong earnings week in the US before the FED interest rate decision meeting on 30th October. With a worsening global geopolitical outlook and the effect of hikes set to take hold of economies, are we set for more news on the dates of potential rate cuts rather than hikes? Time will tell.

US DOLLAR

• The past week saw the greenback lose ground, with the US Dollar index ending the week down 0.4% against a trade weighted basket of its peers. From a data point of view the US showed the economy remains resilient despite elevated interest rates. Retail sales, industrial/manufacturing production and new home sales all beat expectations throughout the week showing economic activity remains high.

• The dollar dipped most sharply on Thursday following a speech by FED chair Powell where he stated the Federal Reserve will proceed “carefully” with forthcoming monetary policy decisions. This prompted markets to fully price out a hike in this month’s interest rate decision meeting and downgrade the chances of a December hike below 25%.

• The FED chair struck a very cautious tone in the press conference as the central bank heads into its blackout period until the two-day meeting commencing on 31st October, where public communications will be very limited. Powell discussed a range of potential threats to the stability of the economy, which the FED now must consider ahead of their upcoming meetings. Most significantly, he emphasised that the impact of the FED’s record rate hikes have yet to fully show their impact on the overall economy. The balancing act of over- or under-tightening is set to hit a crucial phase as the FED must consider the risk of too much tightening and its impact on growth against its primary mandate of price stability.

• From a geopolitical standpoint, the Israel- Hamas conflict has muddied the water when it comes to growth expectations as this poses a number of risks to global economic activity. So far, the impact on financial markets has been less than when Russia invaded Ukraine in February 2022, but this is likely to change if it becomes clear that the situation is moving towards a wider regional conflict involving Hezbollah and Iran.

• A big leap in US borrowing costs has also complicated the FED’s assessment of the need for further tightening. The yield on the benchmark 10-year treasury note jumped to near 5% on Thursday, the highest level since July 2007. This surge in yields has prompted hawkish members of the FED, such as Dallas FED president Lorrie Logan, to soften their stance on the need for further rate rises. Economists are divided over the cause of rising bond yields: it is clear that tighter monetary conditions, political mayhem in Congress, and borrowing expectations all play a role, but there is no consensus on the comparative importance of these factors. Which view the FED takes will influence their decisions. 

ASIA-PACIFIC

• In China we saw CNY remain steady at 7.31 against the dollar. On Wednesday, we saw the first signs of an economic recovery with GDP growth, industrial production, retail sales and employment data all beating expectations. The economy is still grappling with a property crisis, however, with property developer Country Garden confirming a default on its dollar debt. Data released on Friday showed foreign direct investment continues to decline as the world’s second largest economy continues to try and convince global markets of its stability. The figures released on Wednesday appear to be a step in the right direction, but with reports of possible further pain to come for the Chinese financial system – including further pain from the property sector and large volumes of unacknowledged bad debts in small business lending – it is far too soon to say that China is over the worst.

• The Yen weakened against the dollar once again last week as it continues its depreciation towards 150. Data last week showed further declines in industrial production and imports. Exports grew for the first time in 3 months mainly owing to the weakened Yen putting goods at attractive prices. Prime minister Kishida is set to announce an economic stimulus package in Monday’s policy speech in a bid to boost the ailing economy. The scale and composition of this package will determine whether or not it is positive news for the Yen.

• The Aussie steadied against USD last week after a torrid period of depreciation. RBA meeting minutes released on Tuesday showed central bank governors believe further policy tightening may be required to bring inflation back to the target range of 2-3%. A drop in unemployment to 3.6% on Thursday showed the labour market remains extremely tight despite below trend growth and further headwinds from a struggling Chinese economy. Thawing relations ahead of Prime Minister Albanese’s visit to China this week are a positive sign for the Australian economy, which relies on China to buy its raw materials.

SOUTH ASIA

• INR remained steady slightly weaker than 83 vs USD last week as the Indian economy appears to be in good health. There was a small downturn in Wholesale Price Index inflation and manufacturing last week. Overall, however, the Indian economy appears to be in good health as it heads towards 6.5% annualized GDP growth, making it the best-performing large economy.

• PKR remained steady against USD last week, ending the week trading at 278.15. There we no data releases of note as markets look ahead to the central bank interest rate decision on 30th October, where rates are expected to rise to 23.5%.

MIDDLE EAST AND AFRICA

• Nigerian Naira official market rate tumbled by 20% to trade at 999 vs USD. This comes in line with the further weakness in the parallel market as the country grapples with severe dollar shortages. The CBN announced plans last week to sanction banks hoarding dollars to make profits. The incoming government has a big job on its hands to fulfill the promise of reforming the forex market as it continues in its battle to meet debt requirements. Markets look set for a volatile period as the central bank is set to raise interest rates to over 19% on Wednesday.

• The Kenyan Shilling posted another weekly decline of 0.4% against USD, continuing a long-running trend. There were no data releases of note last week as the economy continues to struggle with dollar shortages.

• The Tanzanian Shilling remained steady at 2500 against USD as the central bank and government continue to take measures to address Dollar shortages. There was no major market moving news this week from Tanzania. 

• South African Rand depreciated by 0.1% to trade a touch above 19 Rand to USD. Hotter than expected inflation and a strong retail sales print on Wednesday helped reverse depreciation earlier in the week. The central bank has its interest rate decision next month and will be watching closely for further signs of inflationary pressures as chances of a hike are being revised upwards by market participants. 

EUROPE

• GBP appreciated by 0.2% vs USD last week to end the week trading a touch above 1.215. Data released last week showed average weekly earnings dropped back to their July level. This was backed up by the larger than expected decline in retail sales for September. More concerning, however, was the inflation print on Wednesday which stayed steady at 6.7%. With earnings and activity both down but price pressures lingering it puts the BoE in a tough place as it battles to maintain price stability without affecting growth more severely than necessary. If the BoE is not able to bring inflation down, fears of a stagflationary period will increase. The BoE will be hoping for positive activity PMIs for October this week in order to leave room for additional rate hikes, if needed, to bring inflation down.

• There are several reasons why inflation remains stickier in the UK than in other major economies. The UK imports much of its food from the European Union, a trade that has been adversely affected by weather anomalies and supply chain issues affecting European farmers. Energy prices are higher in the UK because subsidy support for households tapered faster than elsewhere. The labour force participation rate in the UK has declined, making labour markets tighter, supporting wages and consumer spending. And post-Brexit political and economic conditions mean that – unlike in the US – expansion of the supply side of the economy cannot easily occur in response to strong pressure of demand. These constraints are structural and will not ease in the short run, meaning that the BoE is likely to see reducing aggregate demand through high interest rates as its only path.

• The Euro was one of the major gainers last week, up over 0.5% against USD to trade above 1.06 for the first time in 4 weeks. Economic sentiment and current account data showed a welcome sign of resilience in an economy that has endured a torrid 6 months. This helped support the common currency against its peers. Positive growth figures from the trading bloc’s major partner, China, also helped boost the Euro last week as we head into the ECB interest rate decision on Thursday. The consensus is the ECB will hold rates steady at 4% but markets will have a keen eye on Lagarde’s press conference afterwards for signs of any future monetary policy tightening.

OTHER NEWS  

• Egypt’s debt was downgraded deeper into junk by S&P Global Ratings for the second time in October as the North African nation faces severe hard currency shortages. The IMF has delayed disbursement of the latest tranches of assistance and future prospects for the Egyptian fiscal position and currency are linked to geopolitical turmoil in the region, with speculation that Egypt might seek to extract debt concessions from Gulf states in return for opening the Rafah crossing to Palestinian refugees.

• Israel has closed over 100 accounts on crypto exchange Binance, as it looks to block funding to Hamas. With Binance being essentially the only large crypto exchange left standing after the fall of FTX and wrangling with regulators over the shape of future regulatory supervision, headlines like these have implications for the extent to which crypto will become a more mainstream part of the international currency markets.

• The UK, US and France have advised citizens to leave Lebanon as regional tensions rise upon fears of escalation in the Israel-Hamas conflict. Rising levels of fire have been exchanged between Israel and Hezbollah militants in southern Lebanon and Israel has also made evacuations on its own territory. Geopolitical analysts estimate that Iran faces a strategic dilemma: goad Hezbollah into an escalation and risk a direct clash with the US or do nothing and lose credibility with militant groups it backs. Whichever way it decides will have major implications for international markets.

• Argentina’s economy minister, Sergio Massa, has won the first round of the Presidential election over radical candidate Javier Milei as the vote is set to run to a crucial second round. If he wins, look for the Peso to stabilize.

PERFORMANCES AGAINST US DOLLARS

Information as of 2023 October 23rd 09.00 UAE time.

THE WEEK AHEAD

Monday, Oct 23rd

• US Chicago FED National Activity Index

Tuesday, Oct 24th

• Australia Judo Bank Composite PMI Flash

• UK Unemployment Rate

• EU HCOB Composite MI Flash

• UK S&P Global/CIPS/ Composite PMI Flash

• US S&P Global Composite PMI Flash

Wednesday, Oct 25th

• Australia Inflation Rate

• Canada BOC Interest Rate Decision

• US New Home Sales

Thursday, Oct 26th

• ECB Interest Rate Decision

• US Durable Goods Orders

• US GDP Growth Rate Q3

• US Pending Home Sales

Friday, Oct 27th

• Australia PPI

• US Core PCE Price Index

• US Personal Spending/Income