Being predictable can help, especially if it concerns a central bank! The US Federal Reserve (Fed) last week raised its federal funds’ rate by 25 basis points (bps), landing the benchmark in the range of 1.5 to 1.75 percent. However, the sixth such rate-hike since December 2015 – accompanied by Fed giving hints of more aggressive hikes in the coming year – didn’t move the needles of global financial system much. It’s either Fed’s predictability or that the markets don’t share Fed’s views on US economic conditions.
The higher rate ought to have strengthened US dollar and improved long-term bond yields. Au contraire, the dollar index has continued its slide, just as the 10-year US treasury yield has remained flat in the wake of Fed’s decision. The US equities were surely rattled last week, but the shellacking has mostly been attributed to different factors: 1) fears of a Trump-induced trade war, 2) Facebook coming under scrutiny and 3) national-security hawks gaining dominance in Trump’s cabinet.
Surprisingly, unlike last tightening cycle when Fed started raising rates circa 2004, central banks in EU, Japan and many emerging markets (EM) have chosen not to match Fed’s moves this cycle.
EMs like India, Indonesia, Philippines and Taiwan are holding their rates steady while the likes of Brazil, Peru, and Russia have reportedly cut rates lately.
Last week, China responded to Fed’s move, rather casually, by raising its main liquidity-controlling tool (7-day reverse repo rate) by just 5 bps to 2.55 percent.
EM central banks have historically been forced to raise rates to close interest-rate-differential with the US. Not doing that can risk EM capital flight, as it happened in Mexico and Southeast Asian economies back in the nineties. Why is this time different?
One view is that the Fed’s “forward guidance” – official suggestions of orderly, graduated and small rate hikes – is rendering its rate hikes matter less to EMs. Unless something drastic happens at the Fed’s closely-watched meetings, markets and EMs will stay the course, so goes this view.
Some analysts have offered a different explanation for the path divergence.
EM central banks are holding fire for three reasons: 1) the inflation current is still tamed across many EMs, 2) a rebound in commodity prices has helped the commodity-exporting EMs improve their dollar balances, and 3) dollars continues to weaken against a basket of currencies. Trump’s proposed protectionist tariff-imposition against his bête noire, China, is perhaps the curveball that can throw EM central banks off balance.
Unfortunately, Pakistan is not part of the EM resistance. While other EMs have refused to put the brakes on growth; Pakistan’s economy, though expanding on the heels of domestic demand, is undergoing restrictions on credit growth.
A falling import cover has led the authorities here to embark on monetary tightening amid significant, forced depreciation against the greenback. More uncertainty looms as to how much the rupee has further to fall and when the country will go knocking again on the IMF door.
Under PML-N, growth in dollar equity inflows (exports, remittances and FDI) remained largely lackluster, leaving the import financing mainly on external borrowing. The government had to tap expensive foreign commercial loans to help finance some of the current account deficit.
The 3-month Libor, against which pricing for most of Pakistan’s foreign commercial debt is pegged went up from 0.27 percent in June 2013 to 2.2 percent in March 2018.
It looks as if not much of recourse is left but to continue borrowing expensively from abroad for a few more months until the IMF can be meaningfully engaged.