On March 16, local time, the U.S. Federal Reserve's Open Market Committee (FOMC) announced a 25 basis point rate hike, raising the federal funds rate to a range of 0.25%-0.5%. The vote on the resolution was 8 in favor and 1 against, with only St. Louis Fed Governor James Bullard voting against, who insisted on a 50 basis point rate hike. This is the Fed's first rate hike since December 2018.
This rate hike was in line with market expectations. Boots on the ground, there is no worse news is good, the day the three major U.S. stock indexes did not fall but rose, the Dow rose 1.55%, the S&P 500 rose 2.24%, the Nasdaq rose 3.77%.
Meanwhile, the Fed's FOMC March dot plot shows that officials expect a total of seven Fed rate hikes in 2022, or 25 basis points at each FOMC meeting for the rest of the year, with rates at 1.9% by the end of 2022 and 2.8% by the end of 2023.
This means the end of the pandemic easing and the US officially enters a tightening cycle. As the total U.S. economy accounts for 1/4 of the total world economy, the U.S. dollar accounts for about 60% of global foreign exchange reserves and about 80% of international settlements, the Fed's interest rate hike is sure to push the global economy to begin to enter the era of austerity.
How will the Fed's rate hike affect us? Will China cut or raise interest rates? How far can this round of tightening go?
The logic of this article
I. Pre-expansion and post-expansion
Second, internal and external problems
Three, drop more plus less
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01
pre-expansion and post-lag
This rate hike finally landed in the grind. Previously, the March rate hike was already clear; the Russia-Ukraine war added some variables to this hike, but the difference was only whether to add 25 or 50 basis points. The Fed played it safe and chose 25 basis points, while raising the discount rate from 0.25% to 0.5%, in line with market expectations. At the same time, Powell also revealed that the Fed may announce the start of tapering in May at the earliest, the balance sheet framework will be similar to the last time, the speed will be faster than last time.
The Federal Reserve regulates the money market through three main instruments: the federal funds rate, open market operations and the discount rate. Specifically, federal funds are reserves held by commercial banks in the United States at the Federal Reserve Bank, which can be loaned to other member banks. Commercial banks can also borrow directly from the Federal Reserve Bank. The interest rate on such interbank lending is called the federal funds rate. The Federal Funds Rate, which the Fed is able to raise, is the rate at which the Federal Reserve Banks lend directly to commercial banks. Since the Fed is the largest participant in interbank lending, its increase in the lending rate affects the entire industry by increasing the lending rate. Higher interbank lending rates mean higher financing costs for commercial banks, which in turn drives up market lending rates and reduces market liquidity.
Open market operations refer to the buying and selling of bonds by the Federal Reserve Bank in the open market to regulate the quantity of money. When the new crown epidemic global pandemic, the Federal Reserve launched a large-scale quantitative easing (expansion of the table), buying a large number of bonds to directly put dollars into the market; since November last year, the Federal Reserve reduced the scale of bond purchases, and by March this year has ended the quantitative easing; is expected to open the tapering in May this year, selling bonds in the financial market to recover more dollars. The dollar liquidity in the bond market fell, commercial banks' deposit rates and lending rates rose, which in turn pushed up market lending rates.
The Fed may face an unprecedented challenge in the current tightening cycle. The new crown epidemic and pandemic easing have led the U.S. and global economy into a dangerous situation of high inflation and high bubbles (high debt). This year, the Russia-Ukraine war has hit the global economy, which is in a fragile recovery, hard, greatly increasing the risk of stagflation - high inflation and asset bubble collapse.
Today, the Fed's tightening policy faces a dilemma: not enough tightening, it is difficult to control inflation; tightening too much, may collapse the asset bubble.
The Fed missed the best time to end quantitative easing last year, and with the impact of the Russia-Ukraine war, they now face a huge inflation challenge. Data released by the U.S. Department of Labor showed that the Consumer Price Index (CPI) rose 7.9% year-over-year in February, compared to a 7.5% year-over-year increase in January. The spike in energy and food prices triggered by the Russia-Ukraine war will push up the CPI in March.
However, the market is also worried about the Fed's aggressive rate hikes due to inflation leading to a financial collapse. Sweet, head of monetary policy research at Moody's, said, "It's going to be a very aggressive tightening cycle, and I don't know if the Fed can bring the economy to a soft landing, and it's clear they're betting heavily on tackling inflation."
It's a difficult trade-off. It is expected that in the current tightening cycle, the Fed's challenge is "inflation" than "stagflation" in the early part of the cycle, and "stagflation" than "inflation" in the late part of the cycle ". The Federal Reserve forecast, 2022 to 2024 PCE inflation is expected to median 4.3%, 2.7%, 2.3%, respectively, last December was expected to 2.6%, 2.3%, 2.1%. The Fed also significantly lowered its economic growth expectations: the median GDP growth expectations for 2022 to 2024 are 2.8%, 2.2%, 2%, compared to the December expectations of 4%, 2.2%, 2%, respectively. the median unemployment rate expectations for 2022 and 2023 are consistent with the previous forecast of 3.5% (unemployment rate indicator blunted).
From the above forecast data, we can see that in the current tightening cycle, the Fed's policy objective this year is mainly to fight inflation, and the main task each year is to deal with the risk of economic downturn and bubble collapse. The Fed hopes to keep inflation down to 4.3% in 2022, while the CPI was 7.9% in February, the task in the anti-inflation; at the same time, the expected economic growth rate in 2023 will be reduced to 2.2%, worried about recession.
Chart: FOMC March dot plot, source: Federal Reserve, Chippendales
Unlike the tightening strategy of 2016-2018, which was slower before and faster after, the pace of this round of tightening is likely to be slightly stronger in terms of rate hikes and tapering in the early stages and more moderate in the later stages instead. the FOMC March dot plot shows that officials expect a total of seven Fed rate hikes in 2022, with rates at 1.9% by the end of 2022 and 2.8% by the end of 2023. In other words, the expected rate hike in 2022 is 165 basis points, larger than the 90 basis points in 2023.
Federal Reserve Chairman Powell is clear that there are two reasons for the current high CPI: first, monetary factors, the pandemic quantitative easing, stimulating strong demand, that is, real inflation; second, supply factors, the new crown epidemic and the Russian-Ukrainian war hit the supply of energy and raw materials, which in turn pushed up food prices and prices, that is, not real inflation. Powell believes that the Fed has nothing to do with the supply crisis caused by the new crown and war, and all he has to do is to solve the monetary factors, end quantitative easing, raise interest rates and shrink the table.
What will the Fed do if the Russia-Ukraine war and sanctions against Russia do not expand, inflation remains above 6% in 2022, and asset bubbles are in jeopardy? The Fed will still put the fight against inflation first, even if the asset bubble collapses due to tightening. This is where the duty of Fed officials (inflation targeting) lies, a deeply ingrained Volckerian legacy of the Fed, and in line with Friedman's price theory.
If the Fed presses inflation down to the expected target of 4.3% in 2022, then the Fed will be more concerned about the risk of stagflation, i.e., economic downturn and financial collapse. Inflation is the Fed's current challenge, but the Fed's real concern is the financial risk.
The Fed now leans more toward modern monetary theory in its monetary operations. They care less about the quantity of money and are unafraid of inflation. As long as inflation does not break out and the U.S. bond yield curve does not steepen, they are more willing to maintain an accommodative policy and promote the securitization of national assets by issuing dollars - to support the expansion of financial assets. The communiqué of the March rate meeting noted that "the Fed will keep an eye on the broader economic picture as it draws down its balance sheet in the future."
Scott Minerd, chief investment officer at Guggenheim Partners, believes in Friedman's quantity theory of money and is quite unhappy with the Fed's operations today. He charges that the Fed has largely abandoned monetary policy orthodoxy - no commitment to controlling the money supply. scott Minerd believes that the Fed has given excessive attention to financial markets at the expense of its responsibilities in controlling the money supply and managing its balance sheet.
Objectively, the inflation puzzle (as measured by the CPI) is weaker in the U.S. today than it was during the Great Inflation of the 1970s; and the risk of financial asset bubbles is far greater than it was in the 1970s. The more fundamental cause of the Great Inflation at that time, in addition to monetary over-issuance, was the collapse of the U.S. dollar credit due to the breakup of the Bretton Woods system. The collapse of dollar credit led to a full depreciation of the dollar and a full increase in commodity prices. Rebuilding dollar credit is not a one-day process; it is a spontaneous process of repricing the dollar. The subsequent decade of the Great Inflation was one in which the dollar was devalued three times and prices were rediscovered. In fact, the scale of monetary over-issuance today is far greater than it was then, and if we go by Friedman's definition of inflation, today's inflation is far more horrific. It's just that the shape of inflation has changed, from commodity inflation to financial asset inflation. Therefore, what the Fed is really worried about in this tightening cycle is the financial collapse.
02
internal trouble and outside aggression
According to historical experience, each round of monetary easing by the Fed will trigger a flood of global liquidity, emerging countries layer upon layer, financial assets, bonds and real estate bubble expansion; each round of monetary tightening will trigger a decline in global liquidity, emerging countries financial turmoil, global asset bubbles in jeopardy. This is the Fed's plan economy, the Fed's tightening plan triggered pessimistic expectations.
How is the Fed's tightening policy affecting the global economy?
As the world's number one reserve currency and the number one international settlement currency, the impact of the Fed's tightening policy on the global economy is all-encompassing.
First, global liquidity has fallen, financing costs have risen and debt risks have intensified.
The Federal Reserve raised the federal funds rate, driving up the cost of global financing and increasing the cost of debt service for governments and corporations that borrow large amounts of dollar-denominated debt. The U.S. federal government's interest payment costs increase, and the debt service pressure on the U.S. debt of the Turkish government and Evergreen Group increases. When the dollar interest rate continues to rise, the government and corporate debt service capacity of the U.S. debt will reach the threshold and a debt crisis will break out.
Second, bond yields rise, asset prices fluctuate, and asset bubbles collapse.
Bonds, oil, and gold are all hedged products for the U.S. dollar. When the U.S. debt is flooded with depreciation, bonds, oil, and gold become anti-inflationary hedge assets; when the dollar tightens interest rates rise, the dollar becomes scarce and gold expensive, the market recovers liquidity, and bond, oil, and gold prices tend to fall.
The Federal Reserve is the largest holder of U.S. debt. The Fed's tapering directly sells U.S. debt, and the price of U.S. debt falls and bond yields rise. U.S. debt is the anchor of global financial assets pricing, U.S. debt collateral assets shrinkage to increase the risk of financial products, the market has redeemed cash, stocks, funds and other asset prices fell, asset prices may collapse.
Some may feel strange that after the news of the Fed's interest rate hike, the 10-year U.S. bond yield fell instead of rising; at the same time, the three major U.S. stock indexes rose sharply instead. The reason is simple, this time the interest rate hike is playing the clear card, the market digested the risk of interest rate hike in advance. After the outbreak of the Russian-Ukrainian war, ten-year U.S. bond yields slumped, but market expectations after March 6 pushed their yields up rapidly, hitting a new high of 2.239 before the rate hike policy was announced. Both the Dow Jones and Nasdaq began their downward paths in January of this year as the equity markets entered an early tightening cycle. The strength of this rate hike was largely in line with equity market expectations.
The new crown epidemic, monetary easing and the Russian-Ukrainian war drove gold, international crude oil and commodity prices sharply higher. Can a tighter dollar lower commodity prices? The dollar's hedging advantage over commodities is crushing and crude oil and gold cannot compete with the dollar. From a balance sheet perspective, the so-called "dollar" and "petrodollar" no longer exist today. We can briefly review the history of the dollar versus oil, deflation versus inflation.
The collapse of the Bretton Woods system in 1971 led to the collapse of the gold standard system, gold was kicked out of the currency market, and the dollar suffered a credit crisis. Then, the United States fell into a decade of stagflation due to the dollar credit crisis. By 1982 the U.S. economy was facing its darkest moment since the Great Depression, international crude oil and gold prices were soaring, and the Federal Reserve was implementing a highly tightening policy. But at the time, some were questioning the international credit of the dollar, whether the dollar could still compete with gold and oil, and whether austerity could keep inflation down. The Reagan administration's Treasury and Budget Department officials reasoned through models that as long as the Fed insisted on raising interest rates, international capital would abandon anti-inflationary products such as oil and gold and instead buy dollars and dollar-denominated assets in a big way. As a result, gold, oil and commodities prices fell, the dollar rebuilt its credit, the dollar index rose, inflation gradually fell, and a bull market in U.S. stocks began.
Will Saudi oilmen cut dollar payments? Oil trade has a large share of international settlement in US dollars, and when the dollar is flooded, oil traders will increase the proportion of payment in euros, pounds and other currencies as appropriate. If the war between Russia and Ukraine and the sanctions against Russia are no longer expanded, once the dollar enters a channel of appreciation, the proportion of the dollar in international settlements will increase, and oil traders, including Saudi Arabia, have asked for dollar settlements.
International crude oil prices once exceeded $120 a barrel after the outbreak of the Russia-Ukraine war, but expectations of a rate hike drove oil prices back down in recent weeks, releasing risks early. After the news of the rate hike, WTI real-time oil prices rebounded to $97. In the future, the biggest uncertainty of oil price trend is still the Russia-Ukraine war and the sanctions against Russia.
Third, the dollar index rises, emerging countries' currencies depreciate, capital outflows and inflation rise.
When the Fed enters a tightening cycle, other central banks usually follow suit. The reasons for this come from two sources.
On the one hand, the appreciation of the U.S. dollar and the pressure of local currency depreciation, capital outflows and rising inflation may trigger exchange rate risks and financial turmoil. On the other hand, the U.S. dollar is the world's largest reserve currency, and many countries' central banks issue local currency by reserving dollars. A tightening dollar means fewer and more expensive bullets in the hands of other countries' central banks, inhibiting their ability to expand their currencies.
Usually, the bottom of Europe and the United States is good strength enough to dare to tighten or postpone tightening with the Federal Reserve, and emerging countries are caught in a dilemma due to excessive monetary and debt expansion. If it is a fixed exchange rate, it follows the Fed's footsteps; if it is a free exchange rate, it mainly depends on national strength, weakness is to grab and run, strong is to procrastinate; if it is a fixed exchange rate with control, the situation is much more complicated.
Hong Kong, China, has a fixed exchange rate, no central bank, only the Monetary Authority, and a linked exchange rate system. Hong Kong strictly follows the principle of the Impossible Triangle, with the Hong Kong dollar pegged to the US dollar, free circulation of capital and the abandonment of an independent monetary policy. When the Federal Reserve announced a 25 basis point interest rate hike, the Hong Kong Monetary Authority was the first to follow suit, "with the prime rate set at 0.75% according to a pre-set formula". The fact that Hong Kong, China, is running on the same frequency as the giant is a testament to its strong international financial strength.
Mainland China adopts a regulated exchange rate system and the situation is a bit more complicated. Since the second half of last year, the Chinese central bank's monetary policy has been moving in line with the Federal Reserve. Now that the Fed's rate hike has landed, will China's central bank press the pause button to lower interest rates? Some time ago, probably due to the impact of the Russia-Ukraine war, the exit of Chinese concept stocks, the decline of credit data and tightening expectations, market confidence was extremely low and Hong Kong stocks and A-shares plunged continuously. Then, the Financial Stability Conference was held, pointing out that monetary policy should be proactive in response and new loans should maintain moderate growth. The next day, the stock market was greatly revived. It is expected that the central bank will also continue to maintain abundant liquidity in the first half of the year by expanding reverse repo efforts, MLF (medium-term lending facility) and other tools to stabilize expectations and the economy. In the second half of the year, the central bank will find a balance between the external pressure of the Fed's rate hike (exchange rate risk) and the internal pressure of the macroeconomic downturn (debt risk).
Last week's ECB meeting decided to keep the existing accommodative policy unchanged in view of the uncertainty of the war between Russia and Ukraine. President Lagarde said the ECB's rate hike process will be gradual. The ECB is more likely to follow up with a rate hike at the end of the year.
This week is the most critical global central bank super week of the year, with markets focusing on the reaction of central banks in various economies to the Fed's rate hike. The Bank of England has already raised rates ahead of schedule last year and is expected to follow the Fed's lead this time as well, with a third consecutive 25 basis point hike. Brazil's central bank, which has jumped ahead significantly due to soaring inflation last year, is expected to raise its key interest rate for the ninth consecutive time, to 11.75%. Russia, which is in extreme distress due to war and sanctions, with the ruble collapsing and inflation exploding, is expected to continue to raise rates after its 1,050 bps rate hike on February 28. Japan's pace is closer to the ECB and later than the Fed's tightening. Turkey's central bank is of the preemptive thunderstorm, self-destructive type, either staying put or going the other way.
In short, the Fed is entering a tightening cycle and emerging countries are on the verge of a currency crisis.
03
Drop more plus less
How long is the current tightening cycle? How much will the Fed eventually raise interest rates?
Typically, the Fed tightening cycle is 2-3 years, and the FOMC March dot plot expects the federal funds rate to be raised to 2.8% by 2023. Is there a possibility that it will continue to go up? The Fed also can not give the answer, the only answer is the future is full of uncertainty.
However, we can understand the Fed's monetary cycle in terms of a broad cycle of historical experience. Opening the historical chart of the Fed's federal funds rate, starting from 1982, when Volcker fought inflation, we can find two very clear patterns.
For one, the federal funds rate has been stepping down since 1982, all the way down to 0.25% before the current round of rate hikes. In other words, we've actually been in a big easing cycle for the last 40 years.
Second, since 1982, each round of monetary policy of the Federal Reserve has taken asymmetric operations: each time the rate cut is greater than the rate increase. This has led to a step-down in the federal funds rate.
14 points (percentage points) down in the 1982 easing cycle and only 3 points added in the 1988 tightening cycle.
6 points down in the 1990 easing cycle and only 2 more points added in the 1994 tightening cycle.
4 points down in the 2000 easing cycle; nearly 4 points added in the 2005 tightening cycle.
5 point drop in the 2008 easing cycle; only 2.5 point increase in the 2015 tightening cycle.
Rate cuts kick in in August 2019, with the federal funds rate dropping directly to near zero in March 2020.
Figure: Federal funds rate chart, 1982-2022, source: wind, Chippendale
This is an interesting finding. According to Keynesianism, the Fed can borrow public credit to implement "upwind" operations, i.e., to implement easing in a recession, and then take back the excess money when the economy recovers.
However, it is difficult to overturn the water.
The lack of a price mechanism for the right to mint fiat money as a public good and the lack of efficiency in its distribution create incentives for free-riding and can easily degenerate into a tragedy of the commons. If you over-issue money, all are happy; if you tighten it, all are miserable. Keynes was an elitist thinker who envisioned a political elite (economists) independent of government setting monetary policy in accordance with academic neutrality, so as to achieve a neutral interest rate. Volcker was Keynes' ideal chairman, Greenspan was half demon, half god. After the outbreak of the financial crisis, the public "flogged" Greenspan, and after the crisis, the "Three Jets" catered to the public to exercise the right to mint money, easing relentlessly, tightening warily. Of course, this is not the central governor's problem, but the problem of the central banking system.
Each round of big easing blocks market clearing and spawns a flood of poor quality demand, poor quality companies and poor quality assets. For example, the Fed's printing of money to send to households via the Treasury, which stimulates exuberant demand, is poor quality demand - not from real savings, but from real debt. Firms that are fed by the Fed skipping commercial banks and giving loans directly to firms to feed them are inferior firms - market credit is bankrupt; or, firms that can only survive by the Fed pressing market interest rates below the natural rate through easing are inferior firms - Accepting the normal interest rate means bankruptcy. An inferior asset is a monetary bubble that has accumulated entirely from money, such as the real estate bubble and the stock bubble of recent years.
Poor quality demand, poor quality firms and poor quality assets lead to a very fragile economic system, with the entire financial system relying on debt to survive. The Fed slightly raised the federal funds rate, a small increase in market interest rates, has exceeded the debt-servicing capacity of poor-quality enterprises, immediately into a bankruptcy crisis; or, the lack of physical value of financial markets to support the collapse of the bubble because of the decline in liquidity. Such a horrible image, the Federal Reserve simply do not dare to be reluctant to significantly increase the federal funds rate - unless the CPI sprint up. In short, the easing cycle to create a huge amount of debt suppression of the federal funds rate to raise.
As such, we have been living in the Great Easing Cycle for the past forty years, with the Federal Reserve's balance sheet continuing to balloon and the size of federal government bonds increasing massively.
Chart: Changes in the Federal Reserve's asset mix, source: Federal Reserve, Chippendale
Powell started the easing cycle after the federal funds rate was raised to only 2.5% in the last tightening cycle, now can he break his own record this time?
In the last two easing cycles (financial crisis easing and pandemic easing), the Fed implemented a near-zero federal funds rate for a combined period of eight years. The very low interest rates bred a large number of giant infant poor quality companies and poor quality assets. The Fed is not afraid to raise interest rates upwards and started to lower them in August 2019. Now, how to raise interest rates this round?
Currently, the biggest challenge for the Fed comes from the uncertainty of the Russian-Ukrainian war. The communiqué from the March rate meeting noted that the damage to the U.S. economy from the conflict in Ukraine is highly uncertain and that the conflict could have spillover effects on U.S. supply and trade. The war will cause more intricate supply chain issues. Higher energy prices are pushing up inflation, and the Ukraine crisis is causing more upward pressure on inflation.
From the communiqué, it is clear that the Fed is most worried about the energy crisis caused by this war, rather than the surplus agent crisis and sovereign debt crisis. Financial sanctions have resulted in more than half of the Russian central bank's foreign currency being frozen. 16 is the date of interest payments on Russian sovereign bonds, which the Russian side says have been paid out but may not be received by the other side. This may constitute a technical default, but it is not relevant. This is because the exposure to default on Russian sovereign debt is limited. The remaining maturity of Russian sovereign debt during 2022 is $18.27 billion, with dollar debt accounting for about 25% and euro debt for about 0.68%.
This is the last thing the Federal Reserve wants if the expansion of the war and escalation of sanctions leads to further large increases in energy prices. Assuming an extreme scenario where this war causes oil prices to soar above $200 for several months, with U.S. inflation on fire and financial precariousness at the same time, will the Fed continue to raise rates? This time, the Fed will probably press the pause button, if the financial collapse hit the real economy, but also may continue to implement easing policy.
Finally, we look at the Fed's relationship with emerging countries in the context of the great forty-year easing cycle. Over the past 40 years, emerging countries have emerged from joining globalization and are the direct beneficiaries of the Fed's big easing - cheap international capital. 1997 Krugman pointed out that the Asian miracle relying on cheap capital was unsustainable. At that time, the Federal Reserve was in a tightening cycle, and a large amount of capital from Asia retreated to the United States to invest in the emerging Internet market. Then a financial crisis broke out in Asia, and Krugman's fame grew. However, the outbreak of the Internet bubble crisis in 2000 and the "September 11" terrorist attacks the following year, the Federal Reserve cut interest rates significantly, which saved the emerging countries in Asia. 2008 financial crisis, the same script again, the emerging countries each time "lost and recovered After the 2008 financial crisis, the same script played out again, with emerging countries "losing and gaining back" each time.
For the past forty years, even once the Federal Reserve took a slightly stronger tightening measure by raising the federal funds rate above 4%, emerging countries could have faced a disaster like the Japanese bubble crisis.
We often scold the Fed for deflating, but in fact, emerging countries deflate even more. Whether it is a financial crisis easing cycle or a pandemic easing cycle, the total money supply of emerging countries such as Brazil and Turkey - broad money (M2) growth rate is much higher than that of the United States. Many people feel strange, the Federal Reserve engaged in quantitative easing, why the United States broad money growth is so small?
Fed tightening is like pulling wool, which directly raises the cost of financing for commercial banks and tends to push up market interest rates; however, Fed easing is like pushing wool, where the federal funds rate is low, but commercial banks are cautious about lending due to risk considerations. Keynes believed that this is a market failure, called the liquidity trap. In fact, it is called market manifestation. Commercial banks in the United States are private banks, and the interest rate market is a free market. The Fed should thank the commercial banks and free markets, is their self-interest principle to regulate the monetary aggregates, to a certain extent to inhibit the Fed's public interest as the goal of Hu as non-. However, many emerging countries do not have independent central banks, much less private banks, free interest rate markets, the absence of such free markets led to monetary aggregates out of control. This is the root cause of the currency crisis (debt crisis) in emerging countries.
Of course, emerging countries are counting on the United States to first thunderstorm, the Federal Reserve halfway to press the pause button and then directly cut interest rates, as in the 2007 subprime crisis, the 2020 epidemic and the stock market crisis, so that another easing cycle can be mixed. This is a more than rotten times.
