Last week four central banks cut their policy rates, warning of volatility in global financial markets due to uncertainty over when the Federal Reserve will start reducing its asset purchases and the prospect of further harrowing budget talks in Washington.
Five of the seven central banks whose policy committees met last week referred to the U.S. political situation, illustrating how connected the global economy is and thus the worldwide impact of the growing polarization of U.S. politics.
Both Chile and Sri Lanka's central banks, which surprisingly cut their rates, were concerned over the prospects for global growth while the last-minute deal in Washington gave Serbia's central bank room to cut its rates.
Yet, one of the surprises last week was the remarkable resilience of financial markets to the threat of an unprecedented U.S. default with prices showing that investors were taking the threat seriously yet perceiving the chance of such a default as miniscule.
One likely explanation is that investors have become desensitized to repeated bouts of political brinkmanship and mismanagement ever since the first failed vote on the three-page Troubled Asset Relief Program (TARP) in September 2008, which led to a 777 point drop in the Dow Jones average, the largest single-day point drop ever.
A few days later the U.S. Congress passed the bill, creating $700 billion to purchase distressed bank assets, especially mortgage-backed securities.
The episode emphasized how political risk can never be underestimated and that politicians are capable of doing great damage but in most cases eventually listen to economic reality.
Brian Barish, president of Denver-based Cambiar Investors, gave financial markets credit for concluding the entire event was a fake emergency: “We weren’t talking about systemic risk. We were talking about stupidity risk,” he told the Wall Street Journal.
Central banks are clearly nervous that U.S. political dysfunction will return as last week’s deal only reopened the federal government through Jan. 15 and suspended the debt ceiling through Feb. 7.
The Central Bank of Chile, which surprised markets by cutting its rates, said the Federal Reserve’s decision to postpone tapering had led to lower long-term interest rates but the budget deal in Washington was “temporary so further financial tensions cannot be ruled out.”
The National Bank of Serbia, which also cut its rate, welcomed the budget deal as it heralded “positive trends in international financial markets.”
Serbia is an example of those countries that saw their monetary policy decisions influenced earlier this year when it became clear that the Federal Reserve was contemplating winding down quantitative easing. This led to capital outflows, currency depreciation and thus inflationary pressures, limiting the room for the Serbian central bank to cut rates to stimulate economic activity for fear that global investors would withdraw even more capital.
The other central banks that commented on U.S. politics last week issued their statements prior to the 11th hour budget deal.
The Bank of Thailand, which maintained its rates, was clearly nervous over the outcome of the talks, saying the impact of the shutdown of the U.S. federal government should be limited but “failure to lift the debt ceiling poses a substantial risk to global financial and economic stability."
"The region remained exposed to global market volatility amid uncertainties about the timing of QE tapering and the US fiscal impasse," the BOT said, referring to Asia.
The Central Bank of Sri Lanka, which surprised markets by cutting its rates, was clearly concerned over the global economy, saying the, "the heightened uncertainty arising from the delay in announcing tapering of the quantitative easing (QE) by the US Federal Reserve, coupled with the current political impasse experienced by the United States, resulting in a government shutdown and inability to increase the debt ceiling has also increased market volatility."
Singapore’s central bank, the Monetary Authority of Singapore, was restrained in its comments, merely saying that "some volatility in growth rates is likely" in light of the uncertainties that currently characterize the international environment.
The other two central banks that met last week omitted any comments on U.S. politics, with the Bank of Russia focused on anchoring domestic inflation expectations while the Bank of Mozambique cut rates for the third time this year due to on-target inflation.
Last week’s four rate cuts reinforced this year’s trend toward lower rates with policy rates through the first 42 weeks of this reduced 94 times, or 23.4 percent of this year’s 402 policy decisions by the 90 central banks covered by Central Bank News.
This percentage is up from 22.8 percent the previous week but down from 25.3 percent after the first half of 2013, as the trend toward lower rates has begun to weaken in recent months as central banks in several emerging markets raised rates in response to inflationary pressures, in many cases fueled by currency depreciation.
Policy rates worldwide have been raised 22 times or 5.5 percent of this year’s policy decisions, down from 5.6 percent the previous week but up from 4.7 percent at the end of the first half.
LAST WEEK’S (WEEK 42) MONETARY POLICY DECISIONS:
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This week (week 43) seven central banks are scheduled to hold policy meetings, including Namibia, Turkey, Canada, Norway, Sweden, the Philippines and Mexico.
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