Fed’s moves to reverberate through world markets

By Yi Xianrong Source:Global Times Published: 2017/12/14 19:38:39

Illustration: Luo Xuan/GT


After a two-day meeting, the US Federal Reserve on Wednesday raised the target range for the Federal funds rate by one-quarter of a percentage point to 1.25-1.5 percent, sticking to its gradual rate-hike path. Since the interest rate hike was in line with market expectations, and the House of Representatives and Senate have approved separate versions of tax reform, the US stock market got a further boost, with the Standard & Poor's 500 index and the Dow Jones industrial average both hitting new highs.

Unchanged from its projections in September, the Fed still forecast three more rate increases in 2018 and two more in 2019, with rates settling at 2.75 percent in the long run.

Nevertheless, two members of the Federal Open Market Committee (FOMC) voted to leave rates unchanged this time. While the two will not be FOMC voters next year, it still reflects the cautious attitude of Fed board members toward rate hikes.

As the Fed's rate increase had been widely expected by the markets, its spillover effect has already been reflected, and the world's major central banks are reacting to the Fed's move. That is because the global impact of changes in the Fed's monetary policy cannot be underestimated.

More importantly, with the departure of Fed Chair Janet Yellen and vacancies among Fed governors, several major changes are inevitable in the coming year, even though many observers believe that Yellen's replacement, Jerome Powell, is unlikely to make much of a course change. First, it remains to be seen whether Powell will follow the same course as that pursued by Yellen. Second, it is unclear who will be nominated as the new Fed governors next year and whether they will be dovish or hawkish, which will add uncertainty to US monetary policy decisions in 2018.

Third, as most countries have been tightening their monetary policies amid a global economic recovery, 2018 could see global monetary conditions being the tightest in 12 years.

Many analysts already predicted that the average interest rate of developed countries would increase by at least 1 percentage point in 2018. Naturally, such a major shift in monetary conditions will be closely watched by investors.

While the Fed forecast three interest rate hikes in 2018, it is still uncertain what will actually happen, and there may be four or more hikes next year. According to a Bloomberg News report on Monday, with the global economy heading into its strongest period since 2011, Citigroup economists estimate that in 2018, the average rate across advanced economies will climb 0.4 percentage point to 1 percent, which will be the biggest increase since 2006; while JPMorgan projects the average rate to rise to 1.2 percent.

Specifically, Citigroup expects the Fed and Canada's central bank to raise interest rates three times next year, but with only one hike for central banks in the UK, Australia and New Zealand. JPMorgan and Goldman Sachs both project four rate hikes by the Fed in 2018. However, most market analysts still believe that the possibility of a rate hike by the European Central Bank or the Bank of Japan is quite slim in 2018.

Moreover, as 2018 will mark the 10th anniversary of the Fed's quantitative easing, many market analysts predict that the monthly net asset purchases by global major central banks will drop from $126 billion in September to $18 billion at the end of 2018, and will turn negative during the first half of 2019.

This outlook indicates that central banks around the world may accelerate the normalization of their monetary policy stance. For instance, in the US, with falling unemployment, strong trade and business spending, as well as the implementation of the tax overhaul plan, the US economy may perform even better next year than this year. It is also expected that the world economy will expand about 4 percent in 2018, the best performance since 2011.

With the US speeding up the normalization of its monetary policy, countries around the world are expected to tighten their monetary policy on the whole. This trend may have a far-reaching impact on global markets, particularly leading to abnormal changes in capital flows and asset prices. Chinese investors need to watch closely whether a strong US dollar could spur capital outflows from the domestic market and whether it would impair the stability of the yuan's exchange rate in 2018.

It is inevitable for the Fed's normalization of monetary policy to have a proportionate spillover effect on the global economy, and governments and investors should be prepared for further developments next year.

The author is a professor with the College of Economics at Qingdao University. bizopinion@globaltimes.com.cn


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