Global economy braces for QE exit and rate hikes
The dreaded Fed cut is almost here. US Federal Reserve Chairman Jerome Powell has signaled that he will raise interest rates soon, but will also stop adding to his massive stockpile of bonds by early March.
In summary: key support for the global economy is going to be withdrawn sooner than financial markets were betting.
Bloomberg Economics expects Group of Seven central banks to add just $330 billion to their balance sheets this year, down sharply from the more than $8 billion added during the pandemic in a bid to unwind markets, contain borrowing costs and stimulate demand and risk taking .
The two largest U.S. banks have raised their forecasts for how quickly the Fed will raise interest rates this year, with Bank of America predicting a move at every meeting to tackle the highest inflation in four decades.
JPMorgan Chase & Co separately lifted its call for five hikes in 2022 from four previously. Chief U.S. economist Michael Feroli said Powell’s remarks following last Wednesday’s meeting “were clearly intended to deter the market from expecting a quarterly pace of rate hikes.”
Goldman Sachs economists also joined their Wall Street peers in forecasting that the Fed will raise interest rates more aggressively than they had previously expected.
They now predict that the US central bank will raise its near-zero benchmark by 25 basis points five times this year rather than four times.
Meanwhile, Fed counterparts are also ending or slowing the bond buying that accelerated during the coronavirus recession, with some even looking to reverse it.
The Bank of Canada has signaled that it may tighten policy in the coming weeks after ending so-called quantitative easing in October.
Clearly, this is not a synchronized tightening across the global economy.
There is an emerging divergence as major central banks in the English-speaking world seek not only to stop quantitative easing but also to start quantitative tightening, the term given for shrinking balance sheets, while others continue to ease monetary policy.
Japan remains committed to stimulus even as it slows the pace of its asset purchases and the European Central Bank is seen as still more than a year and a half away from a rate hike, although it also cuts its net purchases.
China, which avoided QE during the crisis, went into stimulus mode to protect the economy from a housing meltdown.
The Fed sets monetary policy by adjusting the interest rate that the major banks pay each other for overnight loans: the federal funds rate. Changes in this rate have repercussions on the economy, affecting employment, production and the price of goods and services.
The policy direction of the Fed impacts the entire financial world, especially emerging markets and economies where local currencies are pegged to the dollar.
Amidst all this uncertainty, here is the key question: what does the exit from QE mean for the global economy?
If the tightening allows central banks to rein in runaway inflation, then it could help prolong the recovery from the 2020 crisis, especially if it acts as a substitute for higher benchmark rates.
But if the process ends up disrupting markets, it could backfire by cutting off the flow of credit to consumers and businesses, shaking their confidence.
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