Rate hike fu­els fear

With busi­nesses and con­sumers used to low rates and cheap fund­ing, many be­lieve that the party will end with higher bor­row­ing costs. Will this trig­ger the next cri­sis?

The Star Malaysia - StarBiz - - Front Page - By FINTAN NG fintan@thes­tar.com.my

IMAG­INE a sit­u­a­tion where when­ever you needed it, you could al­ways dip into the kitty and come up with a fist­ful of dol­lars. This is what it was like for the past decade when cen­tral banks around the world, in­clud­ing the United States Fed­eral Re­serve (Fed) and the Euro­pean Cen­tral Bank (ECB), cre­ated money by buy­ing up bonds in the mar­ket, what is known as quan­ti­ta­tive eas­ing (QE).

Mop­ping up these bonds had the ef­fect of mak­ing long-term in­ter­est rates lower, while at the same time, pol­i­cy­mak­ers in these de­vel­oped economies such as the US, the Euro­pean Union and Ja­pan also held down short-term rates by keep­ing key in­ter­est rates low.

At that time, the move to keep in­ter­est rates low was done in or­der to re­vive the econ­omy. The short-term rates are the rates that com­mer­cial banks re­fer to when they set their rates for prop­erty loans, hire-pur­chase and per­sonal fi­nanc­ing loans.

Now that global eco­nomic growth is revving up, pol­i­cy­mak­ers are mulling rais­ing bench­mark in­ter­est rates again, while those cen­tral banks that had cre­ated money in or­der to sup­port growth are ei­ther start­ing to shrink their bal­ance sheet or are plan­ning to do so soon.

Most will fo­cus on what the Fed will do or what the mem­bers of the Fed­eral Open Mar­ket Com­mit­tee will say, as these are the peo­ple who can vote to raise or cut in­ter­est rates. And the Fed is ea­ger to shrink its bal­ance sheet, in­curred through buy­ing US gov­ern­ment bonds and mort­gage-backed se­cu­ri­ties, be­cause it has bal­looned to US$4.52 tril­lion.

The prob­lem with shrink­ing the bal­ance sheet, which the Fed has be­gun from this month, will mean that long-term in­ter­est rates will start to go up. The Fed has also raised short-term in­ter­est rates twice this year af­ter rais­ing it last De­cem­ber. The bench­mark fed­eral funds rate now stands at a range of be­tween 1% and 1.25%. There is at least one more rate hike this year.

Faced with the prospect of higher in­ter­est rates, mean­ing higher bor­row­ing costs, how will busi­nesses and con­sumers re­act? What about those who have bor­rowed at cheaper rates but are now faced with higher rates? Will this trig­ger the next eco­nomic cri­sis?

But econ­o­mists are cau­tion­ing against jump­ing to con­clu­sions. They do not deny that there will be volatil­ity in the fi­nan­cial mar­kets that will have a spillover ef­fect on the real econ­omy. But they ar­gue that any rate hike or “ta­per­ing”, that is a re­duc­tion in the bond-buy­ing pro­gramme used to stim­u­late eco­nomic growth, will be more nu­anced.

UOB KayHian Malaysia Re­search econ­o­mist Ju­lia Goh tells

StarBizWeek that as far as the mar­kets are con­cerned, the Fed will take the grad­ual ap­proach for rate hikes. “It’s go­ing to be mod­est and moder­ate, not likely to dis­rupt the mar­kets. Af­ter all, it took them many years to get out of the re­ces­sion (the 2008/2009 global fi­nan­cial cri­sis). I think they wouldn’t want to hike ag­gres­sively and cause a pull­back in the econ­omy,” she says.

Goh points out that the re­duc­tion of the bal­ance sheet has also not been ag­gres­sive. “The Fed is just let­ting the bonds ma­ture and not rein­vest­ing,” she says, adding that this will be eas­ier for the mar­kets to ab­sorb ver­sus the Fed ag­gres­sively sell­ing down.

Goh says what could cause the mar­kets to be more volatile is when all the cen­tral banks re­duce their stim­u­lus pro­grammes at the same time. “It doesn’t ap­pear that this is the case,” she says. The ECB will be giv­ing more guid­ance on when it will start ta­per­ing at the Oct 26 meet­ing. There are var­i­ous es­ti­mates of how much the ECB will re­duce its bond-buy­ing pro­gramme for next year, which stands at €

60bil per month this year. Some € have es­ti­mated a low of 15bil to € €

20bil to a high of up to 40bil. A re­vi­sion of the eu­ro­zone growth rate to 2.2% from 1.9% does sup­port a re­duc­tion in the bond-buy­ing pro­gramme, but a steadily strenghen­ing euro has stayed the hand of pol­i­cy­mak­ers.

Goh does not be­lieve that the Bank of Ja­pan (BoJ) will raise its key rate soon, as in­fla­tion in Ja­pan con­tin­ues to be low. “The Ja­panese econ­omy is do­ing well but in­fla­tion is still nowhere near the tar­get,” she says. The BoJ has a 2% in­fla­tion tar­get. At the end of Jan­uary last year, the BoJ also in­tro­duced nega- tive in­ter­est rates in the hope it would spur com­mer­cial banks to lend more and con­sumers to spend in­stead of save.


It can­not be de­nied that the global econ­omy has be­come ad­dicted to the cheap money cre­ated by the QE and low in­ter­est rates. Be­cause growth was slower in the ad­vanced economies, cor­po­rate earn­ings took some time to re­cover while the QE meant lower bond yields. In search of growth and yields, in­vestors took their money to emerg­ing mar­kets.

This had the re­sult of in­flat­ing as­set prices – from bonds to prop­er­ties – in the emerg­ing mar­kets. A mea­sure of how dis­rup­tive any ta­per­ing can be came in 2013, dur­ing the “taper tantrum” when thethen Fed chair Ben Ber­nanke said the Fed would start to “taper” the bond-buy­ing pro­gramme. That had a dis­rup­tive ef­fect on mar­kets world­wide and par­tic­u­larly for emerg­ing mar­kets.

Cit­i­group Inc man­ag­ing di­rec­tor for global strat­egy Mark Schofield says in a re­port from last month that it is not cer­tain that ta­per­ing will bring the big in­crease in volatil­ity that many com­men­ta­tors an­tic­i­pate. “The re­al­ity is that it isn’t re­ally pos­si­ble to cre­ate a one­size-fits-all sce­nario for ta­per­ing. Each coun­try will have its own re­sponse and each as­set class will likely see a dif­fer­ent re­ac­tion,” he says.

Schofield says based on a sur­vey, the con­sen­sus seems to be some­where in the mid­dle as to the im­pact of ta­per­ing on the fi­nan­cial mar­kets. “There is a great deal of de­bate as to how sig­nif­i­cant the im­pact of ta­per­ing is likely to be. Some see ta­per­ing as an in­te­gral part of the new phase in the cy­cle and as such think it will have no real im­pact on the global econ­omy, while oth­ers think that it could be the event that fi­nally bursts the bub­ble, lead­ing to a down­ward spi­ral of as­set prices and a bru­tal tight­en­ing of fi­nan­cial con­di­tions

that could tip the econ­omy back into re­ces­sion,” he notes.

How will this im­pact emerg­ing mar­kets, es­pe­cially the ex­ports-re­liant Asean economies al­ready threat­ened by dis­rup­tion of trade flows from pro­tec­tion­ism? There is the very real fear that the QE and in­ter­est rate hikes will have a neg­a­tive im­pact on the fi­nan­cial mar- kets of this re­gion and other emerg­ing mar­kets, and this will even­tu­ally have knock-on ef­fects on the real econ­omy. Emerg­ing-mar­ket cur­ren­cies will bear the brunt of the mar­ket volatil­ity.

AmBank Group chief econ­o­mist An­thony Dass ex­pects some cap­i­tal out­flows from the emerg­ing mar­kets of this re­gion with the ta­per­ing and the rate hikes. “There could be some pres­sure, but I ex­pect some of the coun­tries in this re­gion to even­tu­ally start push­ing up rates. In the case of Malaysia, should in­fla­tion stay around 3% next year, then we may see Bank Ne­gara rais­ing the overnight pol­icy rate by 25 ba­sis points,” he says. This will bring it to 3.25%.

Dass says there is some breath­ing space for mone­tary pol­icy in the re­gion as it re­mains low. “The hikes for emerg­ing mar­kets in this re­gion will be mar­ginal, so rais­ing by 25 ba­sis points is not go­ing to be dis­rup­tive. This is done so that the in­ter­est rate dif­fer­en­tial (be­tween emerg­ing mar­kets and ad­vanced mar­kets) will not be so wide,” he says. Wide in­ter­est rate dif­fer­en­tials will cause volatile cap­i­tal flows, in this case, fund flows in­crease over time back to the ad­vanced economies.

Based on the real ef­fec­tive ex­change rate, the ring­git has been un­der­val­ued since Novem­ber 2014. This means that bor­row­ing costs have been more ex­pen­sive, but Dass ex­pects a stronger ring­git next year rel­a­tive to this year. The house view is for the ring­git to av­er­age be­tween 4.22 and 4.25 against the US dol­lar ver­sus this year’s 4.31 to 4.33.

“If the ring­git ap­pre­ci­ates a bit more, then bor­row­ing costs will be rel­a­tively cheaper than this year,” Dass says, adding that in Malaysia’s case, fun­da­men­tals have im­proved with in­ter­na­tional re­serves above US$100bil, cu­mu­la­tive in­flows into lo­cal eq­ui­ties at RM9.53bil while for­eign share­hold­ing of Malaysian Gov­ern­ment Se­cu­ri­ties is hold­ing steady at 42% (from a low of 38%).

“When you look at this kind of liq­uid­ity num­bers, there is some ap­petite. We’re not off the radar screen, we’re back on the radar screen and give some sup­port to the ring­git, which will help in the bor­row­ing cost pres­sures,” he says.

Tight­en­ing mone­tary pol­icy Liq­uid­ity squeeze High as­set prices Higher debt lev­els

Pol­icy re­view: The US Fed­eral Re­serve build­ing in Wash­ing­ton DC. Now that global eco­nomic growth is revving up, pol­i­cy­mak­ers are mulling about rais­ing bench­mark in­ter­est rates again. — AFP

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