A U.S. Federal Reserve (“Fed”) pivot is felt throughout global markets, affecting economies worldwide.
While developed markets may experience short-term volatility, they typically recover quickly. Emerging and frontier markets, however, are more sensitive to Fed rate changes, often facing severe currency volatility and challenges in securing external debt. This sensitivity arises from several key factors:
- Dollar-denominated debt in many emerging markets ties their financing costs directly to U.S. interest rates.
- Higher U.S. rates typically strengthen the dollar, weakening other currencies.
- Changes in U.S. rates influence global risk appetite, affecting international capital flows.
On September 18th, the Fed began its easing cycle with a 50-basis point rate cut. This action prompted responses from other central banks and policymakers worldwide. The Fed pivot provided China the opportunity to introduce a much-needed stimulus package. Less than a week after the Fed pivot, the People's Bank of China announced a large-scale stimulus—7.5 trillion yuan ($1.07 trillion) package to inject capital into housing and capital markets—without jeopardizing the yuan's stability. The program includes measures to reduce rates on existing mortgages, accelerate the sale of unsold homes, and support equity markets through a reduced reserve requirement ratio and a facility for stock purchases by institutional investors.
The European Central Bank (ECB) also adjusted its monetary policy following the Fed pivot, although the direct causality is less clear. The ECB made its pivot in June 2024, earlier than the Fed, due to more rapidly declining inflation and weaker economic growth. While the timing may not be directly reactionary to the Fed, the U.S. pivot provided the ECB with more flexibility for further rate cuts, particularly as the Euro has been weakening against the dollar. Both the Eurozone and U.S. face similar challenges of sluggish economic growth, high (but declining) inflation, and cooling labor markets, but specific factors within these economies informed the timing and magnitude of their respective rate cuts.
Not all central banks have followed suit, however. Some have adopted a more conservative "watch-and-wait" approach. The Reserve Bank of India, despite recent softening of inflation to within its 2 - 6 percent target, has not indicated imminent rate cuts. The bank's governor has even criticized the U.S. pivot as "very risky." Similarly, the Bank of England has maintained steady rates despite near-target inflation and the Fed pivot. These decisions reflect a more gradual and conservative approach to controlling inflation compared to the U.S.' proactive stance.
As seen in the table above, U.S. equity markets have responded well to the Fed's pivot, posting a positive return as well as continued strength in the dollar. China's stimulus appears to have achieved its intended effects for both the yuan and their equity markets, minimizing depreciation of the yuan while spurring outsized growth in the equity markets. In both cases, the performance underscores the immediate impact of monetary easing, though it remains to be seen if such growth will be sustained.
Unfortunately, the same cannot be said for the Euro, which has suffered a significant downturn against the USD, diminishing what would otherwise be a strong equity return for the same period. This raises questions about Lagarde's decision to cut rates again in the face of an already weakening Euro. The ECB seems to be prioritizing economic growth over currency stability for the time being, but it is unclear whether this approach will prevail over time.
The countries in the "watch-and-wait" camp have experienced slight currency depreciation with little to no support from the equity markets to soften the blow. These are the expected challenges of a more conservative approach in an environment where many central banks are easing.
As the Fed continues its easing cycle, it remains unclear whether the more cautious countries like India and the UK will eventually follow suit or maintain their conservative stance. This uncertainty adds another layer of complexity to the global economic outlook. The potential for widening policy divergences could lead to further disparities in economic performance across regions.
Moving forward, it will be crucial to monitor the long-term sustainability of these varied approaches and the potential global economic imbalances that may arise, particularly if the gap between proactive and conservative policy stances continues to widen.
