Doubt about future rate hikes

Considering the high inflation environment and the uncertainty of economic growth prospects, the Fed has different ideas in the choice of future interest rate hike paths.

On the one hand, the US inflation situation is not optimistic. The Russian-Ukrainian conflict and subsequent sanctions have sent global commodity prices soaring, which could continue to push up U.S. inflation in the coming months.

The U.S. Federal Reserve announced a rate hike on the 16th, raising the target range for the federal funds rate by 25 basis points to between 0.25% and 0.5%. It is likely just the start of a series of increases intended to curb runaway inflation.

Analysts believed that in the context of high inflation and high uncertainty in the geopolitical environment, there are challenges in the choice of the Fed’s future rate hike path. At the same time, the Fed’s interest rate hike may increase the risk of global debt default.

Former Treasury Secretary Lawrence Summers wrote in The Washington Post on the 15^th that the Fed needs to “take far stronger action” than just raising rates. He noted that the United States is facing huge inflationary pressures, including rising energy prices, food prices rising caused by the conflict between Russia and Ukraine, and increasing supply chain disruptions caused by the rebound of the new crown epidemic. All factors above may push up the US inflation rate by 3 percentage points during the year.

The latest economic outlook forecast released by the Federal Reserve on the 16th shows that the US inflation rate is expected to rise to 4.3% this year, and the core inflation rate after excluding food and energy prices is 4.1%- far above the Fed’s annual target of 2.3%.

U.S. News pointed out that before Russia invaded Ukraine last month, conditions were already difficult for the Fed. Consumer price inflation is running at a 7.9% annual rate, while oil prices have risen sharply as demand recovered more than expected from the damage of the restrictions imposed to halt the coronavirus.

A few days ago, the chairman of America’s central bank Jerome Powell said at a congressional hearing that he’ll propose a quarter-point hike, rather than a half-point, suggesting that’s likely what the Fed’s policymaking committee will approve. However, he noted that the Fed is prepaid to possibly lift rates more sharply, depending on the effects of the Ukraine war and other developments.

On the other hand, the conflict between Russia and Ukraine has exacerbated the global supply imbalance and affected the US economic recovery. Fed officials have taken a more pessimistic view of the U.S. economic outlook, projecting a 2.8% U.S. economic growth rate in 2022- down 1.2 percentage points from their December forecast.

BBC reports that: “The Fed is not alone in its plans to raise interest rates from their current levels. The Bank of England raised interest rates twice in three months and drew outrage when its boss asked workers not to ask for a pay rise to try to stop prices rising out of control.”

Looking ahead, Jerome Powell said that the Fed expects inflation “to decline over the year as supply constraints ease… we are attentive to the risks of potential further upward pressure” on prices. He cautioned, however, that the invasion of Ukraine, and sanctions imposed by Western countries, create a great deal of uncertainty around the prices of wheat, oil, and other goods.

“The near-term effects on the US economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain,” he said in his semi-annual testimony to Congress.

On the 16^th, oil prices surged again despite the US and other members of the International Energy Agency agreeing to release 60 million barrels of emergency stockpiles. Russia is one of the world’s largest oil and gas exporters, but US President Biden has not ruled out banning imports from the country.

The impact of Fed rate hikes on the rest of the world

A rate hike by the Federal Reserve may not only exacerbate U.S. debt risks; but also increase the cost of repayment of U.S. dollar debt in emerging markets and developing economies, which pushes up global debt default risks.

According to data released by the U.S. Treasury Department a few days ago, the size of the U.S. federal government’s debt has exceeded $30 trillion, about $7 trillion higher than the U.S. gross domestic product (GDP) last year. As the world’s largest debtor country, the US has accelerated its debt scale in recent years, with an increase of nearly $7 trillion since the outbreak of the COVID-19 epidemic.

At the same time, U.S. corporate debt is at high levels and less resistant to monetary tightening. At the end of September 2021, corporate bond issuance by U.S. companies reached $10 trillion, according to the Securities Industry and Financial Markets Association, about 30 percent more than at the end of 2015. Among them, low-grade bonds with higher debt default risk accounted for about 20%.

The Fed’s interest rate hike may exacerbate the risk of the debt crisis in the world, especially in emerging markets and developing economies. Debt in these economies has grown dramatically since the onset of the Covid-19 pandemic.

Data released by the World Bank showed that since 1970, the world has experienced four stages of debt accumulation, which involves more than 100 economies, triggering financial crises in many emerging markets and developing economies. The most recent debt accumulation began in 2010, and it is the most serious and continues to this day.

The British research institute “Jubilee Debt Campaign” released a report showing that the average share of debt service in emerging markets and developing economies in fiscal revenue will rise from 6.8% in 2010 to 14.3% in 2021. The report highlighted the global size of the debt and the seriousness of the debt risk.

Desmond Lachman, a senior fellow at the American Enterprise Institute, told that debt in emerging market and developing economies is at an unprecedented high level and is extremely vulnerable in an environment of rate hike cycles and slowing global recovery. The global economy should prepare for a possible wave of debt defaults in emerging markets and developing economies.

IMF Managing Director Kristalina Georgieva said during a video conference of the 2022 World Economic Forum in January that tightening monetary policy by the Federal Reserve could hit some economies whose recovery is already weak, especially those Economies with higher U.S. dollar debt. As higher U.S. interest rates could make it more expensive for these economies to service their dollar-denominated debt. About 60% of the world’s low-income economies are already in debt distress. The lack of international support and aid could lead to “big trouble”, she said.

By Shiyue Luo