19 September 2019
The US Federal Reserve rarely considers the economic conditions in other countries in determining monetary policy. Photo: Bloomberg
The US Federal Reserve rarely considers the economic conditions in other countries in determining monetary policy. Photo: Bloomberg

Delay in rate hike won’t support global markets

The US Federal Reserve decided to delay the liftoff last week amid market turmoil in China and other emerging markets.

It’s widely expected that the move will give some time for emerging markets to stabilize. However, Fed chairwoman Janet Yellen and other Fed officials didn’t rule out the possibility of a rate hike in October.

It’s quite odd. As we know, the Fed only has two mandates in determining its monetary policy, namely employment and inflation.

It has rarely considered other factors, unless that would involve US interests. For example, Japan suffered from stagnant economic growth for nearly a quarter of a century, but Fed never said it would take that into account.

Meanwhile, if the Fed has to consider the economic performance of China and other emerging economies as a factor in its monetary policy, why were Fed officials so keen on hinting at a rate hike within this year?

Fed’s effort to postpone the rate hike may not reverse the economic woes facing emerging markets. Delaying the liftoff by one or two months won’t change the real economic situation fundamentally.

In terms of US economic performance, inflation pressure remains modest, while there are still concerns about the recovery of the job market, particularly the low participation rate.

So will the current economic situation in the United States justify the zero interest rate policy or long-time low rate?

Both the short-term and long-term interest rates are falling to new lows over the 5,000-year history of human beings, according to data from the Bank of England.

Political factor is a key reason behind Fed’s move. The normalization of the Fed rate policy will become clearer after the summit of US President Barack Obama and Chinese leader Xi Jinping.

Beijing might unveil a new round of market rescue measures after the meeting.

If the Fed liftoff occurs within this year or early 2016, the correction of commodity prices and economic slowdown in emerging markets may accelerate, which in turn would weigh on global equity markets.

Market turmoil in emerging markets will also drag US economic growth, which may prompt Fed to give up further rate hike or even consider a new quantitative easing program. It will be a fairly quick process.

However, if the Fed abandons the rate liftoff because of weak external economic conditions, especially in China, commodity prices and emerging economies may continue to struggle given the sustained strength of the US dollar.

That will also affect global stock markets and ripple into the US market eventually. The Fed will also consider another QE. But the whole process may take place a lot more slowly.

Global financial markets may continue to suffer in the fourth quarter of this year or early 2016, unless the Fed gives up the liftoff and launch QE4 eventually.

The US market usually posts a correction of 10 percent or more before any new QE program. US equities and even global equities would undergo a tough patch before any new stimulus program.

Global financial markets may continue to witness huge volatility, and investors should closely watch emerging market currencies and commodity prices, which would signal any further market deterioration.

This article appeared in the Hong Kong Economic Journal on Sept. 24.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist