Macroscope | Investors may expect the Fed to blink as the economic outlook darkens. It won’t

Nicholas Spiro says recent falls in the US dollar and bond yield reveal markets are – again – reading too much into statements by central bankers

Despite the stock stumbles and signs of a slowing economy, there are more reasons for the Fed to keep up its interest rate hikes than reverse course

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Federal Reserve chairman Jerome Powell speaks at a news conference in March this year. The Fed is sure to tread carefully: if it were to suddenly call an end to its rate-hiking cycle, it would send a worrying signal about the health of America’s economy. Photo: AP

Published: 3:30pm, 22 Nov 2018Updated: 10:22pm, 22 Nov 2018

Emerging market currencies have enjoyed a respite of late. Since falling to its lowest level this year on September 11, the MSCI Emerging Markets Currency Index, a gauge of the performance of developing market currencies, has since risen 1.6 per cent, with most of the increase occurring in November. Even some of the most vulnerable currencies, such as the Turkish lira and the South African rand, have experienced sharp gains since early September.

This is mainly due to the recent swings in the US dollar which, following a strong rally between April and August, has been more volatile in recent months. The dollar index – a measure of the performance of the greenback against a basket of its peers – shot up to its highest level this year on November 12 but has since lost 0.8 per cent.

The greenback has come under pressure because of recent comments from influential Federal Reserve policymakers, notably Fed vice-chairman Richard Clarida, who pointed to the recent slowdown in the global economy and confirmed that US interest rates are moving towards a neutral level. Even Fed chair Jerome Powell hinted at the possibility of a pause in the rate-hiking cycle next year in a discussion last week.

These comments, which were treated by bond markets as distinctly dovish, were enough to cause a sharp repricing of interest rate expectations. The policy-sensitive two-year Treasury yield has dropped 15 basis points since November 7 to 2.81 per cent while investors are now pricing in just under half of the three additional rate hikes forecast by the Fed in 2019, according to data from Bloomberg.

Randal Quarles, vice-chairman of supervision at the US Fed, speaks during a Federal Reserve Board meeting in Washington, DC, on October 31. Recent comments by Fed policymakers were treated by bond markets as dovish, causing a sharp repricing of interest rate expectations. Photo: Bloomberg

Markets are sensitive to any sign that the Fed is backing away from its plan to keep raising rates because of long-standing concerns that the US central bank is at risk of committing a policy mistake, given the relatively subdued level of inflation. On Tuesday, the 10-year “break-even” rate – a market measure of investors’ expectations of US inflation over a 10-year period – fell below 2 per cent for the first time this year, accentuating the growing nervousness in markets about a slowdown in growth.

Macroscope | Investors may expect the Fed to blink as the economic outlook darkens. It won’t

Nicholas Spiro says recent falls in the US dollar and bond yield reveal markets are – again – reading too much into statements by central bankers Despite the stock stumbles and signs of a slowing economy, there are more reasons for the Fed to keep up its interest rate hikes than reverse course

Nicholas Spiro says recent falls in the US dollar and bond yield reveal markets are – again – reading too much into statements by central bankers

Despite the stock stumbles and signs of a slowing economy, there are more reasons for the Fed to keep up its interest rate hikes than reverse course