Tuesday, January 5, 2016

Monetary Policy in Review: Global rates rise in 2015 and set to grind higher in 2016 as Fed continues to normalize

    Global interest rates rose in 2015 and are likely to rise further this year as the U.S. Federal Reserve continues to normalize its monetary policy while the European Central Bank (ECB) and the Bank of Japan (BOJ) remain committed to ultra-low rates and unconventional monetary policy to overcome sluggish economic growth and weak inflation.
    The Global Monetary Policy Rate (GMPR), the average policy rate of the 90 central banks tracked by Central Bank News, rose to 6.27 percent by the end of 2015, up from 5.56 percent at the end of 2014 and the highest rate since 2008 when it averaged 7.43 percent before it plunged in 2009 as central banks slashed rates in response to the global financial cries.
    Policy rates were raised 76 times in 2015, up from 52 times in 2014, with three-quarters of the hikes (55) in the second half of the year as the Fed’s well-telegraphed rate hike approached.
   The Fed's tightening on Dec. 16 came exactly seven years after its last rate cut in 2008, a symbol that the global economy was finally starting to put the ravages of the global financial crises to rest.
   Nevertheless, 2015 will still be remembered as a year of rate cuts, especially in the first half of the year, as the slowdown in China rippled through crude oil and commodity markets.

    Year starts with a bang
    The year started with a series of surprises from central banks, ranging from the Reserve Bank of India's unscheduled rate cut on Jan. 15, followed by the Swiss National Bank's scrapping of its cap on the franc's exchange rate on the same day, the Bank of Canada's first rate cut in six years on Jan. 21 and the Bank of Russia's rate cut on Jan. 30, only six weeks after an emergency rate hike.
    Two-thirds of the 86 rate cuts in 2015 came in the first half of the year as the central banks of Australia, China, the ECB, Denmark, Sweden and New Zealand - to name a few of the major central banks - followed suit and eased their policy, in some cases pushing rates into negative territory.
    The result was that 48 different central banks and monetary authorities eased their policy stance in 2015 in response to economic weakness and decelerating inflation compared with 34 central banks that tightened, mostly in response to inflationary pressures from currency depreciation.  (Click for full details of easing and tightening in 2015)
    The global cocktail of weak growth and currency volatility led to a flurry of central bank activity. Central banks changed their rates 162 times in 2015 compared with only 117 times in 2014.
    Markets digest Fed hike
    After another bout of financial market volatility in August - triggered by the decision of the People's Bank of China to devalue the yuan by letting market forces play a larger role - the global economy stabilized and the U.S. economy continued its "moderate" (in Fed speak) expansion.
    Despite doomsday scenarios, financial markets had little trouble digesting the Fed’s first tightening of monetary policy since July 2006, a testimony to its clear communication and efforts to ensure that investors were not wrong-footed.
   Emerging market assets were considered vulnerable to the Fed’s rate hike but these were also calm in the aftermath, most likely because a shift in prices had been taking place ever since the “taper tantrum” in May 2013 when Fed Chairman Ben Bernanke first floated the idea of “tapering” asset purchases, a change that was then approved at the Fed’s policy-meeting in December 2013.
    One of the consequences of how well the Fed signaled its intentions was that individual central banks worldwide were able to continue on their previous policy paths without having to change direction in response to a sudden shift in markets.
    The day following the Fed’s rate hike, Taiwan’s central bank cut its rate for the second time while Armenia’s central bank the following week cut its rate for the third time in 2015.
    Karnit Flug, governor of the Bank of Israel, aptly described the Fed’s move as helping reduce the lack of clarity surrounding the policy of the major central banks at a time of increased uncertainty due to geopolitical events in Europe and Israel.

    Policy Transmission
    With the Federal Reserve currently setting its sights on an additional four rate hikes in 2016, the U.S. dollar is likely to remain strong, especially against the euro and yen.
    The transmission of the Fed’s tighter policy to other countries occurs mainly through two channels.
    Though bond markets, given the global benchmark role of U.S. Treasuries, and through foreign exchange markets due to the role of the U.S. dollar in everything from international trade, commodities, international reserves or exchange rate pegs.
    Over the last two years, exchange rates have been the main mechanism for transmitting the Fed’s gradual tightening that got underway in October 2014 when it wrapped up QE3, its third program of asset purchases since October 2008.
    The prospect of higher yields, based on the prospects of continued improvement in the U.S. economy, has attracted global investors to the U.S. dollar , helping drive up its value against most currencies since mid-2014 and curb inflation.
    The flip side of the stronger dollar is a weakening of the currency of other countries, which means they have to pay more of their local currency for imports, fuelling inflation.
    Although the prices of most commodities, including oil, have fallen in response to the slowdown in China, the impact on inflation in many countries has been muted because raw materials are largely priced in the U.S. dollar that has risen.
    As the mandate of central banks is now almost universally aimed at tackling inflation, the rise in inflation from exchange rate depreciation has triggered domestic rate hikes, especially in smaller, less-developed countries.
    Central banks from developed or emerging markets accounted for only one-quarter of last year’s 76 rate hikes while central banks from frontier and other markets accounted for 75 percent.
    Many of the rate hikes by smaller central banks were substantial in an effort to show resolve and  fend off attacks, sometimes of a speculative nature, on their currencies.
    Moldova, for example, raised its rate by 1,300 basis points in 2015, while Ukraine raised it by 1,600 basis points before rowing back some of this increase as the currency stabilized.

DEC 28-JAN 2, 2015:
COUNTRY       DATE           RATE      LATEST        YTD     1 YR AGO    MSCI
ISRAEL 28-Dec 0.10% 0 -15 0.25%       DM
KYRGYZ REPUBLIC 28-Dec 10.00% 0 -50 10.50%
SRI LANKA 30-Dec 6.00% 0 -50 6.50%       FM
MOLDOVA 30-Dec 19.50% 0 1300 6.50%
BULGARIA 30-Dec 0.01% 0 0 0.01%       FM
DOMINICAN REPUB. 30-Dec 5.00% 0 -125 6.25%


THIS WEEK: (Week 1 of 2016) Romania is the only central bank scheduled to decide on monetary policy.

JAN 4-JAN 9, 2016:
COUNTRY       DATE           RATE      LATEST        YTD     1 YR AGO    MSCI
ROMANIA 7-Jan 1.75% 0 0 2.50%       FM


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