Macro Insights Weekly: Year of higher rates

Pandemic resurgence versus US monetary policy normalisation are the two big themes for early 2022. On track inflation and labour market goals are paving the way for the latter.
Taimur Baig, Duncan Tan10 Jan 2022
  • Omicron has spread at a pace unmatched by any of its predecessors
  • This is interrupting considerably the re-opening dynamic that was in the making
  • Assuming the fallout remains manageable, the markets’ focus would be Fed policy lift-off
  • We think the first hike in Fed Funds rate to be in March, with 150bps in rate increases in 22-23
  • Some difficulty in EM debt service is inevitable against this backdrop
Photo credit: AFP Photo (Jerome Powell)

Commentary: Year of higher rates

The new year has stayed with the contrasting theme that marked end-21. Omicron, the latest variant of concern in the pandemic, has spread at a pace unmatched by any of its predecessors, interrupting the re-opening dynamic that was in the making. As schools and workplaces have second thoughts about increasing in-person presence, and travel plans and public events are postponed, the pandemic’s damage is extended. Only saving grace is the apparent mildness of the vast growing infection rates worldwide. We are keeping our fingers crossed.

The strategy to deal with this latest wave is informed by relatively high rates of vaccination, which ought to keep a lid on serious illness and deaths. However, massive infection outbreaks (which will likely include many cases of breakthrough infection on the vaccinated) would still cause workplace absence that would exacerbate the shortage of frontline workers and stress healthcare systems.

Many countries are re-introducing lockdowns and mobility stringencies of various types, but it is clear that tolerance for renewed restrictions has reached its limit in most societies. Caught between the need to prevent hospitals from reaching capacity and unacceptance of full lockdowns, the middle ground of vaccine and booster mandates, along with strict mask wearing, is the scenario likely to be embraced by most policy makers.

The pandemic is going to delay resumption of international tourism and events, on the next chapter of the global economic cycle, two trends have emerged. First is the normalization of US Federal Reserve’s monetary policy stance. Second is the sustained effort by the Chinese authorities to support their economy from slumping. On the second theme, the issues at hand for China are clear, but risky nonetheless. Looser monetary and fiscal policy, support for banks and local governments likely to suffer from exposure to a weakening property market, safeguarding consumers from asset market stress, property market volatility, and pandemic measures, and finally, reduce the wide range of uncertainties stemming for recent regulatory crackdowns. The more pressing issue for the global economy is however the first theme flagged above.

A buoyant housing market, elevated fuel prices, and the risk of a tight labour market feeding into higher wages are outshining the concerns stemming from the pandemic’s latest wave in the US, pushing Fed policy makers to turn increasingly hawkish. We think asset purchases would end this quarter and the first hike in Fed Funds rate will take place in March, given that labour and jobs market objectives are well within the Fed’s reach.

What kind of a hike cycle is ahead? We think no more than 150bps over the next two years as the supply side would expand and demand would moderate. Would this be tremendously negative for the global economy and markets? There the answer is mixed, as the ability to absorb even a moderate rise in interest rate is limited in some parts of emerging markets. Also, asset prices, as frothy as they are, will likely see corrections as safe asset returns rise. What could undo the tightening narrative? We can think of three scenarios—a major pandemic setback; global asset market correction; and disorderly slowdown in China.

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Taimur Baig, Ph.D.

Chief Economist - Global

Duncan Tan

Rates Strategist - Asia

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