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Will Other Central Banks Follow the Fed?

August 5, 2019 by

On July 31, the US Federal Reserve has announced a 25 basis points interest rate cut. At the accompanying press conference, the Fed’s Chair Jerome Powell hinted that this rate cut is not a start of some kind of a long-term dovish policy. However, according to the CME FedWatch tool, the probability of the next interest rate cut in September is 100%. Moreover, traders in fed funds futures price the chance of two or more cuts by the end of the year at 75% probability.

Historically, the federal funds rate set by the US FOMC has been quite influential globally, with many central banks (CB’s) trying to adjust their rates in accordance with their US counterpart. This happens because a lot of countries have strong trade ties with the USA and because the US dollar is used as a currency of international trade even when the USA is not one of the participating counterparts. As the level of economic globalization rises, the boom and boost cycles of individual countries become more and more interconnected. This means that a probable slowdown in one country (especially such a big one as the United States) signals an imminent slowdown in other countries, which prompts other central banks to reflect the Fed’s stance in their decisions. This works in the opposite direction too. Slowdown in foreign economies, which results in CB’s lowering their rates, causes the Fed to revise its own monetary policy.

The chart below shows how many central banks increased (hawkish) or decreased (dovish) their interest rates during a year for the period from 2001 through 2019 (until August, 5). It is built using the data from our interest rates table, which lists rates from 31 central banks. As you can see, the world’s central banks have reacted to the 2000–2001 and 2007–2008 recessions in a rather coordinated, albeit delayed, manner — for example, there was no hawkish CB in 2009, with 29 of 31 CB’s cutting rates that year. After a brief, and obviously premature, switch to global hawkishness in 2010–2011, central banks returned to net cutting their interest rates, getting to an even level in 2017 and moving to global hawkishness in 2018. In 2019, there already have been 13 central banks who cut the rates as of August 5 compared to the year’s start. This stands against only two hawkish central banks during the period:

The chart showing a number of hawkish and dovish central banks by year from 2001 through August 5, 2019

The chart does not include all central banks in the world, but it is based on the world’s most influential institutions that are important to Forex traders, making it an appropriate sample to measure the global interest rate mood. It is important to note that the chart does not take into account the size of the cuts/hikes.

It now seems likely that the 2019 will be another switch to a dovish mood among the world’s central bankers — not unlike the one from 2012. It also appears that the 2018 switch to hawkishness was a mistake and that the global interest rates should have stayed lower during a much longer period of time.

Or perhaps, we are just entering a stabilization phase that will last only briefly (through 2019–2020, for example), during which time the central banks will figure out the optimal rates for the prevailing macroeconomic and geopolitical conditions. After all, there is no clear formula for CB’s to follow when setting their rates — they have to resort to a reactive monetary policy, which may include U-turns on their trajectories.

And what is your opinion on this?

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If you have some questions about how central banks set their monetary policy or if you want to share an idea on the global path of interest rates, please use the commentary form to post them.

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