World Insights: U.S. Fed's policy U-turn sparks spillovers, builds up burden of world economies

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by Xinhua writer Ma Qian

BEIJING, May 12 (Xinhua) -- As U.S. inflation, announced on Wednesday, hit an annual rate of 8.3 percent in April, the second straight month with an inflation over 8 percent, market fears mounted over the Federal Reserve's further tightening measures and the widespread headwinds they may possibly trigger across the world.

Adverse spillovers from the Fed's latest sizeable interest rate hike are rippling out to many economies, unleashing more volatility in the global financial markets and overshadowing the post-pandemic recovery amid rising recession concerns. By raising its benchmark rate by half a percentage point, the U.S. central bank has made an abrupt U-turn from its easy monetary policies, adopted since the COVID-19 pandemic, to a more aggressive tightening mode.

The sharpest rate hike in over 20 years, aimed at quelling America's highest inflation in 40-plus years, has nevertheless aggravated the debt burden and currency depreciation pressure of other world economies.

Besides, the Fed also announced plans to scale back its holdings of government bonds and mortgage-backed securities by 47.5 billion U.S. dollars per month on its 9 trillion-dollar balance sheet since June. The move has prompted central bankers of many other countries to speed up their shift away from easy money. Analysts caution that such a trend will further lift borrowing costs and risk drying up liquidity worldwide.


Analysts warn that significant changes in U.S. monetary policies will make it more expensive for emerging markets that borrow in dollars to pay their debt, and stand to undermine investor confidence in those countries. This can possibly trigger capital flight that would directly impact their exchange rates.

The Fed's bold move could tighten financial conditions globally and lead to capital outflows and currency depreciation in emerging markets, and the ensuing inflationary pressure is "very disruptive," explained Ehab al-Desouki, head of the Economy Department of Cairo-based Sadat Academy.

The viewpoint was echoed by Argentine economist Jorge Marchini, who believes the Fed's sharp rate hike could deal a blow to low-income countries and developing economies, particularly Latin American countries that have taken on a large quantities of debt due to the pandemic.

The impact is "enormous" especially for Argentina, the largest debtor to the IMF. "A rising interest rate obviously means a bigger (debt) burden," as Argentina's internal and external commitments are managed through variable rates set by the Fed rate, he added.

What's more, the Fed rate increase could strain ties between developing and lower-income countries in Latin America that struggle with their balance of payments, by sparking "a competition to devalue the currency," the economist warned.

Take Brazil as an example. "When the U.S. increased interest rates, much more capital will move from Brazil to the U.S., which will depreciate Brazilian currency," said Hsia Hua Sheng, associate professor of finance at Getulio Vargas Foundation's Sao Paulo School of Business Administration (FGV-EAESP). "To fight the inflation effect, probably the Brazilian central bank will make its interest rate higher than expected."

Advanced economies are also under growing strain due to Fed's policy shift, which, by pushing up the value of the dollar, will widen the gap between the dollar and other currencies, and also push up commodity prices denominated in the dollar, thus stoking volatility in the financial and foreign exchange markets worldwide.

Japan's economic recovery will bear greater pressure as the Fed speeds up interest rate hike and the gap between the yen and the dollar further increases, analysts said. Last month, the IMF cut its forecast for Japan's economic growth this year by 0.9 percentage points to 2.4 percent.

Nomura Research Institute researcher Takahide Kiuchi said the accelerated U.S. interest rate is the biggest reason for the yen's weakness. As the yen-dollar gap has widened, the trend of Japanese households reallocating their financial assets and selling the yen has caught the attention of the market.

The yen has weakened markedly this year as U.S. monetary policy has been tightening since the Fed started its rate hike cycle in March with a 25-basis-point rise. In particular, the yen has fallen nearly 15 percent against the dollar since March.

Noticeably, South Korea's finance ministry said last week that preemptive measures would be necessary to tackle the financial market volatility at home and abroad following the Fed's rate hike.

Vice Minister of Economy and Finance Lee Eog-weon told a meeting with economy and finance officials that external uncertainties continued to run high and the government will proactively tackle the risk factors, if needed, in a bold and expeditious manner.

"The global economy will continue to be on the downside this year," Joo Won, deputy director at South Korea's Hyundai Research Institute, told Xinhua, adding that the Fed raising interest rate too fast will likely tip the United States into an economic slowdown.


The Fed's latest balance sheet runoff, or quantitative tightening (QT), marks a faster pace than the last time the Fed shrank its portfolio, several years after the Great Recession between 2007 and 2009. As the stark monetary policy shift continues to reverberate worldwide, more central banks are turning to fiscal contraction and scrambling to cope with inflation and dollar-denominated debt.

Concerns over global inflation have imposed additional constraints on monetary policies for many countries, Cai Daolu, visiting senior fellow of the Department of Strategy and Policy of the Business School of the National University of Singapore, told Xinhua, adding central banks often tend to increase their target rates as a way to contain and anchor inflation expectations.

"The U.S. interest rate hike will definitely have negative impact on global capital liquidity and increase the borrowing costs, which will hurt business expansion and economic recovery. This might not be good news to the world's slow economic recovery," Wichai Kinchong Choi, senior vice president of Thai bank Kasikornbank, told Xinhua.

The Reserve Bank of India (RBI) surprisingly raised its repo rate last week to 4.4 percent, from the record low 4 percent it has been held for the past two years.

The monetary policy tightening in the advanced countries will have a significant impact on "trade and investment flows for the developing world," said Dr. Shashanka Bhide, member of the Monetary Policy Committee of RBI, India's central bank, in a statement.

"It was not a question of whether, but a question of when (to raise interest rates). Obviously, the decision has been influenced by the U.S. Fed rate hike," Tulsi Jayakumar, professor of Economics at the S.P. Jain Institute of Management & Research, told Xinhua.

"Foreign investments/funds/bonds arriving in India depend on interest rates in India, and they have to be above U.S. interest rates. Only then the investors find it profitable or beneficial," said Sunil Sinha, principal economist & director of Public Finance with India Ratings and Research.

As the global commodity markets and the currencies of all Gulf states except Kuwait are tied to the dollar, four major Gulf countries -- Saudi Arabia, the United Arab Emirates, Bahrain and Qatar -- raised their key interest rates by 50 basis points in response to the Fed's move last week.

Saudi Arabian economist Mohamed Yusuf explained that the Gulf countries did so to prevent money from flowing back to the United States or other places with higher-yielding dollar-based investments.

The Bank of England (BoE) also raised interest rates last week by 25 basis points to 1 percent, the highest since 2009, to tame inflation now heading above 10 percent, despite the risk of plunging Britain into recession. It also unveiled a plan to start selling off its 20-billion-pound (24.9 billion dollars) corporate bond portfolio in September.

"Some degree of further tightening in monetary policy may still be appropriate in the coming months," BoE policymakers confirmed in a report.

Likewise, while the European Central Bank has signaled it will end quantitative easing in the third quarter, the Bank of Canada is expected to slash its holdings of government debt by 40 percent over the next two years.

Bloomberg Economics estimates that policymakers in the Group of Seven countries will shrink their balance sheets by about 410 billion dollars in the remainder of 2022, which it calls "a stark turnaround" from last year, and warned of "the dual impact of shrinking balance sheets and higher interest rates" on the struggling global economy.

"Still, the combination of QT, rising short-term rates, a strong dollar, higher commodity prices and U.S. fiscal contraction presents the U.S. and world with a major headwind," Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments, earlier told Bloomberg.


Since inflation has consistently burned hotter than expected, economists and critics say the U.S. central bank has waited for too long to tighten monetary policy effectively, building up recession fears with a harsh rate hike.

Jamie Dimon, chairman and chief executive of JP Morgan, said the Fed should have acted quicker. "We're a little late. The sooner they move the better," he told Bloomberg TV last week.

As there's no historical experience that suggests with such a high inflation, the Fed is able to bring inflation down to its 2-percent goal without a recession, some pointed out the limits of Fed's policy tools.

"We believe that there is little monetary policy can do to calm inflation in the near term," Nancy Davis, founder of Connecticut-based Quadratic Capital Management, wrote in a recent report, referring to the limited effects of Fed's policy tools.

Noting that "a recession at this stage is almost inevitable," Former Fed Vice Chair Roger Ferguson told CNBC earlier last week that the Fed won't be able to address the supply side of the issue, which is driving most of the inflation problem.

Stephen Miller, investment strategist at Australian funds management firm GSFM, even raised the alert in his report that the Fed "is now engaged in the most delicate of central bank high-wire acts."

"Through a demonstrated complacence about the magnitude and momentum in inflation through 2021, the engineering of a 'first-best' solution might now be beyond the Fed," he wrote.

In a recent CNN poll, a majority of U.S. adults believe U.S. President Joe Biden's policies have hurt the economy, with 8 in 10 saying the U.S. government isn't doing enough to combat inflation. Enditem

(Xinhua writer Xia Lin in New York City, Xiong Maoling in Washington D.C. also contributed to the story.)

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