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The Federal Reserve, America's central bank, wields one of the most potent forms of influence: interest rates. Using this tool can raise or lower the cost of borrowing across the economy, affecting how much consumers spend and how businesses invest. Traditionally, the fallout from a Fed rate change is felt strongly around the world. However, a new analysis by The Wall Street Journal suggests that its moves don't hit as hard these days. Now, with data and actual examples, do we see why the rate hikes by the Fed will have less influence over the world's economy in 2024 than they did five years ago?
The World Before 2019: A World More Interconnected
Before 2008, there was extreme interconnectedness in the global economy. Think about it:
US Dollar Assets Exposures: In 2007, foreign holdings of US Treasury securities peaked at a high of $5.8 trillion - US Department of the Treasury, indicating the extent to which global banking is exposed to assets denominated in the US dollar.
Impact on Emerging Markets: A study in 2006 by the World Bank, Global Economic Prospects, December 2006, has noted that for each 1% increase in US interest rates, the currency of emerging markets depreciates by 0.5 percent. The currency depreciation may act as a drag on economic growth through more expensive import prices.
The shift post-2019: a less-synchronized world
The global financial crisis in 2008 and the subsequent actions taken by all central banks, including QE, altered the path of global economic affairs. Having learned the risks of relying on foreign capital, emerging markets took measures to develop their domestic financial systems and reduce their dependency on the US dollar. Here is how the data reflects this change:
Foreign Exchange Reserves: China, for instance, has amassed colossal foreign exchange reserves amounting to over $3.3 trillion as of March 2024 (People's Bank of China) to shield against currency fluctuations that might emanate from US monetary policy.
Growth in the Domestic Bond Market: India's domestic bond market size has grown to over $ 6 trillion as of December 2023 (Reserve Bank of India), offering an alternative for investment to US Treasuries, thereby lessening dependency on foreign capital flows.
Live Examples: Central Banks Take Charge
China's Central Bank (PBOC): When the Fed raised rates by 0.5% in December 2023, the PBOC held its benchmark interest rate steady while concentrating on stimulating its own slowing economy. This singular move showed China's new confidence in handling its independent monetary policy.
Central Bank of Brazil (BCB): While the Fed has consistently hiked rates through multiple rounds over 2023, the BCB has kept the interest rate pretty much steady to combat high inflation in Brazil. Thus, the example outlines how emerging economies are more likely to keep domestic economic conditions paramount rather than follow the Fed blindly.
Beyond De-Dollarization: Statistics Don't Lie
There are various other factors to the muted effect of Fed rate hikes:
The Emergence of Regional Central Banks: The central banks of the Association of Southeast Asian Nations (ASEAN) have recently been working in tandem on monetary policy, according to Bangkok Post, "ASEAN central banks vow to cooperate on monetary policy," February 2024. This allows the players involved to have a more regional reaction to changes in the global economy, such as an upward adjustment in the rates as announced by the Fed.
The Globalization of Trade:
The share of international trade deals denominated in US dollars has fallen from over 60% in 2009 to less than 45% in 2023.
There has been a very strong increase in intra-regional trade in Asia, thereby reducing its dependency on the US and Europe.
Caution: This Is Not Business as Usual
As much as it can be said the power of Fed rate hikes has been blunted, experts warn we should not be too hasty in dismissing their impact altogether.
Dr. Mark Zandi, chief economist at Moody's Analytics, said, "The Fed remains a powerful force in the global financial system. A very aggressive rate hike cycle by the Fed, especially if accompanied by a significant dollar strengthening, could still trigger financial market volatility and disrupt capital flows to emerging markets."
The Fed is beginning to be increasingly identified with the world economy.
