The threats are modest but growing, from the fragile state of some emerging markets seen in the collapse of the Turkish lira to a slowdown in Europe that could make the European Central Bank delay the expected start of its own rate increases.That would leave the Fed stranded as the only major central bank that is tightening policy, and in effect with three levers at once as it raises interest rates, cuts its asset holdings, and does so in a global environment likely to drive the dollar higher and make it harder on US exporters.
“The geopolitics have been turbulent. The Turkish situation has been significant: the fall in the lira, the devaluation, has been fast, and the speed of that change caught a lot of folks by surprise, us as well,” Atlanta Fed President Raphael Bostic said on Monday in Kingsport, Tenn, though so far it is not enough to change his view the Fed should raise rates once more this year, given the boost he sees coming from fiscal stimulus.
“Right now we are still analyzing and assessing, but it is definitely something we worry about,” Bostic said.
Central bankers from around the world gather in Wyoming this week for an annual research conference focused on technical topics of market structure. But when Fed chair Jerome Powell addresses the group Friday the attention will be on a broader question: how long can the Fed continue raising rates if it’s the only dancer at the ball?
Smaller players including Canada and Britain have raised rates based on local circumstances. But absent comparable moves from the Fed’s immediate peers — particularly the ECB — the Fed’s rate increases may bite more than expected. Higher US rates and the strength of the US economy will likely boost the dollar, putting US exports under pressure and raising the risk of trouble among countries or companies with dollar-denominated loans.
The recent news from Frankfurt has not been encouraging, with slowing growth forecasts that may make it less likely the ECB would raise rates, as currently expected, beginning late next year. The International Monetary Fund’s recent global review concluded that downside risks were increasing even as the global economy continued to expand.
Since April the dollar has risen about six percent against a global basket of currencies, and the gap between US and German 10-year bond yields has widened half a percentage point since the start of the year. The Fed is expected to raise rates at its September meeting and policymakers foresee a likely increase in December as well, an outlook traders share, according to data from the CME Group.
But in 2019 the paths diverge. Fed officials are penciling in three rate increases for the year and markets anticipating only one or two as the US economic expansion trundles toward its 12th year of steady growth.
“Turkey by itself is not the problem. What it signals is you cannot have one central bank moving and no one else. Something will dislocate,” said Joe Lavorgna, chief economist for Natixis.
Fed policymakers watch overseas events closely but say they react only if global developments affect the US economy. Still, that has historically given them a wide berth to shape their outlook based on what is happening elsewhere, responding not just to data but to changes in perceived risks.
The Turkish lira’s slide has little in common with the Thai baht devaluation in the late 1990s that preceded a larger crisis in emerging markets, or to the debt problems in Greece that raised the spectacle of the euro zone breaking apart. Both events raised direct risks to US growth and financial stability and reshaped Fed policy in real time.
Published in Daily Times, August 22nd 2018.