The Federal Reserve can’t wait to start raising interest rates, as confirmed by the Fed again yesterday.
Meanwhile, central bankers in emerging markets can’t cut rates quickly enough to avoid deflation.
Twenty-one global central banks have cut their benchmark interest rates this year according to Bloomberg, often multiple times in a desperate bid to escape the clutches of deflation. This includes major, developed economies like Australia and Sweden as well as developing economies including China and Russia.
|The Fed is sticking with its game plan to hike interest rates later this year.|
The U.S. Fed by contrast seems dead set on raising our cost of money.
The majority of monetary easing so far this year has occurred in emerging markets, including all four of the BRICs (Brazil, Russia, India and China). In fact, emerging market central bankers are struggling to lower real interest rates as inflation is falling even faster than benchmark interest rates — a curious conundrum indeed!
Real interest rates are a measure of the benchmark rate of interest in a country, minus the inflation rate. So in the U.S. for example, the Fed has officially left benchmark interest rates unchanged at 0.25 percent since last year, but the latest inflation reading of -0.1 percent year over year for the Consumer Price Index (CPI) has resulted in higher real interest rates of 0.35 percent.
This explains at least in part why both the U.S. economy and stocks have struggled recently, because higher real rates are a drag on growth.
In the emerging world, real interest rates are also on the rise threatening growth. Real rates (adjusted for inflation) are higher now than at the start of the year in South Korea, Poland, South Africa and Israel. For India and China, real rates have barely budged in spite of central bank rate cuts.
The result: Monetary policy has actually become tighter in recent months despite central bank rate cuts.
Rather that helping boost growth rates, higher real interest rates are becoming a stiff headwind for global economies.
Case in point: Yesterday morning we learned the U.S. economy unexpectedly slowed to a standstill last quarter with GDP growth barely registering a pulse at 0.2 percent year over year. Economists had expected a 1 percent gain in GDP, down from 2.2 percent in the fourth quarter. This continues the alarming downtrend we’ve seen in the economic data recently, as I highlighted last week in Money and Markets.
But yesterday afternoon’s message from the Federal Reserve was basically business as usual with the sharp slowdown in U.S. growth attributed to “transitory factors.” Apparently the Fed is sticking with its game plan to hike interest rates later this year, which would only intensify the deflationary headwinds.
The only antidote known to central bankers to revive economic growth in recent years has been more quantitative easing (QE). The European Central Bank launched a $1.2 trillion QE program in March, and recent economic data out of Europe has improved.
After falling four straight months, CPI inflation is expected to be unchanged in April. The economic improvement has been reflected in European stock prices which are up over 20 percent year to date.
And just the mere hint of possible QE by the People’s Bank of China recently has sent stock prices in Shanghai and Hong Kong soaring.
The Fed by contrast is playing lone-wolf when it comes to monetary policy; one of the few remaining global central banks planning to hike interest rates.
Meanwhile, corporate profits are falling fast, which is not a bullish sign for business investment and capital spending. Companies with healthy profits tend to hire more workers and expand operations. Unprofitable companies do not.
And yesterday’s GDP report clearly shows that while consumer spending has held up reasonably well so far, business investment was a noticeable drag on growth.
U.S. inflation has now been consistently below the Fed’s 2 percent “goal” for 34 months in a row. If the Fed is so “data dependent” as they claim to be, will they really stay the course in hiking interest rates, or will the Fed blink? Stay tuned.