Abstract: This CF40 briefing assesses the spillover of major central banks’ monetary tightening and suggests solutions for the global financial market.
I. IN THE FACE OF INTEREST RATE HIKES, GLOBAL RISK AVERSION AND FINANCIAL MARKET VOLATILITY ARE INCREASING
To combat high inflation, the Federal Reserve has raised interest rates six times since March 2021, raising 75 basis points four times in a row and 375 basis points overall.
As a result, the global market has entered a "risk-off mode," with asset price volatility increasing. According to BNY Mellon, US dollar purchases have reached their highest level in three years, while the euro position has reached a new low, and the pound position has also reached a new low since 2014, indicating that investors are selling a large number of non-dollar assets while increasing their holdings of US dollar assets. International capital is rushing back to the United States.
This will undoubtedly exacerbate the global shortage of US dollar liquidity, which will have a huge impact on emerging markets and developing countries, and the developed economies will not be immune: The euro, British pound, Australian dollar, and other non-US currencies have depreciated, and Japan, which has always been regarded as a safe-haven currency, has also depreciated sharply to a 24-year low; major economy stock markets have fluctuated sharply, with the US S&P 500 index falling by more than 20% and stock markets in Japan, South Korea, and Europe all falling sharply.
Some believe that the Fed's rate hikes are causing greater volatility in the financial markets than in the past. There are two main reasons for this. First, the market significantly underestimated inflationary pressures in the United States and then the Fed's determination to control inflation. This underestimation and misjudgment exacerbated the market adjustment. Second, this round of Fed rate hikes, combined with factors such as the pandemic and geopolitical conflicts, has increased the global financial market's uncertainty. Market participants must break free from the original asset pricing framework and devise a new transaction price range through trial and error. This trial-and-error behavior has also increased market noise, causing irrational market shocks.
II. THE SHORT-TERM INFLATION RETREAT CAN HARDLY REVERSE THE MARKET PESSIMISM
The Consumer Price Index (CPI) of the United States is of great concern to the market as it is a vital indicator for interest rate hikes by the Federal Reserve. Data released by the US Department of Labor on November 10 revealed that the CPI growth slowed to 7.7% year-on-year in October from 8.2% in the prior month, below market expectations by 0.2 percentage points. It is good news for investors, for it indicates that US inflation may have peaked and the Federal Reserve may slow interest rate hikes. As a result, global financial markets have rallied dramatically since the data was released, with the NASDAQ jumping 7.35%.
However, many panelists believe that the inflation slowdown will neither stop the Fed from raising interest rates nor dispel market fears of a global recession.
First, US inflation remains grim, and the Fed’s rate hikes have not peaked yet. Despite the slowdown, the absolute value of the October data is much higher than the Fed’s average inflation targeting. Moreover, disaggregated CPI data shows that food and energy prices remain high, and service prices such as housing remain resilient. Given the uncertainty in international energy prices, US inflation is still at risk of rebounding. Therefore, one month of cooling inflation will not change the Fed’s established plan for rate hikes. The Fed will continue to raise interest rates unless inflation keeps cooling.
Second, persistent high-interest rates threaten global financial stability and may even bring systemic financial risks. The dot plot shows that the federal funds rate could rise to 4.25%-4.5% by the end of this year, with a median target rate of 4.6% expected in 2023. As the US interest rate hikes impose more widespread spillover effects, a synchronized rise in global interest rates is bound to threaten global financial stability.
