Global Investors, large and small, are grappling with the timely dilemma of when will central banks begin to cut base interest rates from their current levels in combating inflation from the post-pandemic supply shock issues, increase levels of government borrowing, and recent wage demands, especially in countries such as the UK?
The Bank of England is currently holding its base rate at 5.25% in view of recent declining inflation expectations and an easing labour market. The European Central Bank in September raised its base rate to 4% with its largest economy Germany reporting weak export growth with a 0.5% economic contraction forecast for 2023 remaining a strong possibility.
In the US the federal Reserve current benchmark level for base rates is currently 5.25-5.5% with many institutions and commentators still expecting further rises. However, after recent Federal Reserve official comment which has produced some positive momentum in the stock market at the time of writing suggests to some that a pause to further rate hikes becomes more likely.
Notably, US Treasury debt issuance has increased fivefold from time of the financial crisis in 2008 to 2023 with a market issuance of some US$25tn (FT, 2023). The concern being the US Treasury secretary Janet Yellen is no longer able to borrow huge amounts at low levels of interest. This means US debt servicing costs are poised to balloon with all the emerging budgetary constraints that such a development will create for Federal spending programmes and the wider economy. Both global investors and US institutions will require higher rates to buy further debt issuance, especially longer dated bonds. This is not good news for the White House and the Biden administration.
All of which produces speculation over which course global economies will follow whether one of recession, resilience, or stagflation leaving investors with no asset class to hide in, except cash where inflationary effects take their painful toll. Notwithstanding, higher interest payments and finance costs erode both profit margins for investors and crimp consumer demand therefore reducing overall economic activities. But that is the effect of raising rates especially from their recent historic lows- isn’t that the overall goal.
Thus, what more is there to do as raising interest rates often seems both a curse and a cure in the process of taming inflation in a global economy with depleted supply capacity due to floods or drought, wars, and production shortages after years of money supply increases from quantitative easing in major economies. This was all well flagged by economic commentators and often said overdue.
Is there anymore than can be done to help major economies whether US, Germany, China, or the UK except to begin cutting rates as soon as possible?
The answer perhaps lies with clever fiscal incentives for using investors’ considerable cash reserves sitting in cash funds to finance renewables projects in energy transition, infrastructure for electric vehicles or energy efficiency for buildings. Some more relaxing of rules or the removal of unnecessary administrators to allow lending to entrepreneurs or new business from pension schemes as proposed at the last budget should be further welcomed.
However, the higher rates for longer are something investors and consumers alike will have to endure certainly for 2023 and well in to 2024 as the size of the US Treasury market is not going to diminish and neither are the wars or climate problems causing the supply shortages so slower growth and lower demand will have to suffice to tame inflationary pressures. Meanwhile, the manipulation or sanction-busting activities of food supplies or commodities in the more problematic areas of the world is food for thought for another blog.
As a word of encouragement there is always something to look forward to when rates do start to fall so positioning oneself for later, although hard to do, is well worth consideration. The world keeps turning.
LDC. October 2023
Further Reading and References-
Financial Times, 2023 ‘Huge US Government Borrowing Adds to Bond market Pain’ by M. Duguid and M. McDougall, Financial Times Group 2023, Available Online at: Huge US government borrowing adds to bond market pain | Financial Times (ft.com) (website accessed 6th October 2023).
Evening Standard, 2023 ‘Global Stocks Sink Amid Pressure From Rising US Yields’ by A. Wise, Available Online at MSN.Com 2023: Global stocks sink amid pressure from rising US yields (msn.com) (website accessed 9th October 2023).