Central Bank Rate Hikes: How Fast and How Much?
11/29/2017 2:31 pm EST
The question of how fast and how much to raise rates continues to dominate markets, but the lesson of the year has been that rate hikes don’t matter until they slow the economy, writes Bob Savage, CEO of Track Research over the weekend.
Question for the Week: When will central bank rate hikes matter?
Rate hike risks into 2018 remain central to trading for 2017 year-end.
The FOMC is widely expected to raise rates again in December lifting U.S. rates 1% over the last year.
The key barometer for when hikes like 1% matter reverts to the shape of the yield curve – where front-end rates are expected to remain below longer ones if growth and inflation expectations are robust.
However, after years of QE and negative rates, liquidity trap fears persist on the path toward normalization. The question of how fast and how much to raise rates continues to dominate markets, but the lesson of the year has been that rate hikes don’t matter until they slow the economy. Real global coordinated growth begets real higher global rates.
Bitcoin (BTC) sets a new record high over $9000 last week up 12% [and flirted with $11,000 Wednesday] – as we live increasingly online and virtual– all this despite another cryptocurrency hack of a wallet at Tether.
FOMC December hike but 2018 less clear – Minutes/Yellen still matter. The minutes extended a rally Wednesday (Nov. 22) that followed Yellen’s dovish inflation comments Tuesday night - Fed minutes on core inflation: “Readings continuing to surprise on the downside, however, many participants observed that there was some likelihood that inflation might remain below 2 percent for longer than they currently expected.”
And, “Several participants expressed concern that the persistently weak inflation data could lead to a decline in longer-term inflation expectations or may have done so already.”
The next big hurdle for markets is the December FOMC meeting – where a 25bps hike has been priced – but the outlook for 2018 is less clear.
There is a binary nature to the market with some expecting 3-4 hikes and others 1-2 – with inflation, growth and the makeup of the new FOMC board all key factors and all uncertain.
Rates and forex still correlate – particularly in China. The Chinese yuan (CNY/USD) fixing at 6.5810 Friday – strongest since Oct. 12 - and 10Y yields at 4% are evidence.
The squeeze for funds by banks due to tighter regulation and a campaign to force deleveraging continues. Primary market rates on three-month NCDs (negotiable certificates of deposit) issued by joint-stock banks rose to 4.9100% on Friday, the highest since early June, up from 4.57% Oct 30.
A total of CNY2.1 trillion yuan of NCDs are set to mature in December, the second-highest monthly total since the instruments were introduced by the PBOC in December 2013, this follows CNY1.8trn maturing in November.
The cost of other types of funding is also rising. The Ministry of Finance's latest auction of three-month deposits on Nov. 17 saw a yield of 4.6%, up from 4.42% in October and the highest since early 2015. The key question to ask is: “Does this reflect China moving to letting the market set rates and more accurately reflect the cost of credit?”
The follow-up question is also key: “Whether this will last – if growth slows as a result of regulation and higher rates will policy return to easy?”