How are interest rates going?  It only got more complicated

How are interest rates going? It only got more complicated

Officials noted that while monetary tightening tends to have a quick impact on financial conditions, the full impact on the broader economy took longer to be felt.

“Regarding the current circumstances, many participants noted that while the tightening of monetary policy is clearly affecting financial conditions and has had a notable impact in some interest-rate-sensitive sectors, the timing of the impact on broader economic activity, the labor market and inflation was still quite uncertain as the full extent of the impact had yet to be appreciated.”

Wall Street took the protocol kindly and closed significantly higher towards Thanksgiving. Recognition:PA

That’s a long-winded way of saying that monetary policy works with long lags between interest rate decisions and their economic impact. It can take a year to 18 months for the full effect to appear.

However, financial markets are forward-looking, reflecting expectations of conditions a year or 18 months from now.

US markets are signaling a recession.

The US yield curve has inverted, with shorter-dated fixed income securities yielding higher yields than longer-dated securities. This is in contrast to the normal form of yield curves, where investors are compensated for the higher risk of holding bonds longer. Every post-war US recession has been preceded by an inversion of the yield curve.

The Fed’s new “slower, but higher and longer” monetary policy approach has implications not only for the US economy and financial markets, but also for other central banks, including our own.

Despite recent gains, the stock market is more than 15 percent below its starting point this year, with the most interest-rate-sensitive tech stocks falling nearly 28 percent.

The economic and financial indicators are not only pointing to a recession in the US economy.

Europe, with its particular war-related challenges, is clearly headed for recession, and the recent major COVID outbreak in China does not bode well for an easing of the strict zero-COVID policy that is weighing heavily on its skinny country. economic growth by Chinese standards.

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It therefore makes sense to do as the RBA does, and the Fed is now easing, and taking monetary policy a little more cautiously until the impact of past policies can be assessed.

“Final interest rates” may or may not end up higher, but the risk of excessive monetary tightening and causing more economic damage than is needed to bring inflation under control would be reduced.

There is also a risk to financial stability if central banks become too aggressive in responding to inflation rates that remain unsustainably high even at their peak.

As discussed earlier this week, there are signs of stress in the key government bond market, with unusually high volatility and unusually low liquidity.

Noting the “elevated interest rate volatility and evidence of tight liquidity conditions” in the Treasury market, Fed officials said the market was still functioning properly.

The Australian dollar jumped after the greenback weakened.

The Australian dollar jumped after the greenback weakened. Recognition:Louie Douvis

But they pointed to the recent “disruptions” in the UK bond market and said they underscored the value of the government bond market’s resilience. A number of potential regulatory reforms that could enhance that resilience have been discussed, including capital and liquidity rules, clearing and settlement practices, and the role and structure of the Fed’s own facilities.

Several pointed to the risks posed by non-bank financial institutions amid rapid global monetary tightening and the potential for hidden leverage within these institutions to amplify shocks.

The role that hedge funds and high-frequency traders now play in the government bond market – the world’s most important financial market – has recently become the focus of considerable attention from both regulators and market participants.

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The Fed’s new “slower, but higher and longer” monetary policy approach has implications not only for the US economy and financial markets, but also for other central banks, including our own.

Monetary policy outside the US is forced to largely mimic that of the Fed if it is to reduce the risk of interest rates diverging too far from US interest rates, which would threaten significant currency depreciation that would contribute to inflation (especially higher domestic energy prices). , since oil and gas are quoted in US dollars) and could lead to destabilizing capital outflows.

The US dollar weakened in response to the minutes’ release, falling about 6 percent this month against the basket of currencies from its major trading partners. To some extent, this alleviates an external source of pressure for the RBA and its non-US peers, although the US dollar remains about 11 percent higher than at the start of the year.

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