Fed holds rates steady, indicates it is not ready to start cutting.

In a substantially changed statement that concluded the central bank’s two-day meeting this week, the Federal Open Market Committee removed language that had indicated a willingness to keep raising interest rates until inflation had been brought under control and was on its way toward the Fed’s 2% inflation goal.

However, it also said there are no plans yet to cut rates, with inflation still running above the central bank’s target. The statement further provided limit ed guidance that it was done hiking, only outlining factors that will go into “adjustments” to policy.

Meanwhile, Japan is the outlier as it did not engage in monetary tightening, bar some modest relaxation on the limit s for 10-year JGB yields, and it will likely lift policy rates this year as others ease. But besides Japan there was a synchronised tightening of policy and there will be a synchronised easing. It won’t be coordinated because central banks will come to their own decisions about rate cuts; it is just that they will probably decide to start cutting rates at a broadly similar time.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy said this synchronisation has important implications. One, which we have spoken about before, is that if the banks move together it limit s the room for interest rate differentials to change materially, and this, in turn, can quell currency volatility. Policy rates have soared in recent years, but currency movement has been limit ed, particularly in the case of euro/dollar, because central banks have broadly moved together.

Assuming they ease in a similarly synchronised way, it seems likely that the impact of their policies on currencies will also be limit ed. But there is another aspect to this synchronisation, which is that co-movement in monetary policy can increase the global spillover effects.

What we mean here in simple terms is that the global impact of tighter policy is likely to be greater if all central banks are almost acting as one, rather than moving at distinctly different times and/or at different speeds, or even diverging completely. This seems to make sense, but some worry that synchronous rate hikes can cause monetary conditions to tighten too much on a global level because central banks only properly consider the impact of their own rate hikes, and not everybody else’s.

Perhaps fortunately, warnings that synchronised policy tightening could lead to deep recessions have not materialised, at least not so far. But now the boot is on the other foot, and we’re looking at the synchronized easing of policy by G10 central banks. Does this run the risk of creating excessively large monetary stimulation at a global level and so creating problems, such as a return of inflation or bubbles in financial asset prices such as equities?

Only time will tell on this one. The factors that suggest little cause for alarm include the prior observation that synchronous tightening did not plunge the economy into a deep recession, so perhaps fears about synchronous tightening were overblown, and the same will prove to be the case when central banks ease.

Another point is that central banks hiked rates quickly and in large amounts, but on the way down, they will presumably act more slowly and cut rates in smaller amounts. While such factors might give us hope, we feel that it is necessary to address the elephant in the room; the inflated balance sheets of central banks as a result of QE. Might the fact that global growth held up better than expected in the tightening cycle have to do with the fact that sharp rate hikes were pushing against the cushion of the excess liquidity?

In the distant past, when central bank balance sheets were more normal and banks had fewer reserves at their disposal, synchronous policy tightening might have caused much more economic and financial distress. In short, we always have to distinguish between a pre-QE world and a post-QE world. Right now, as central banks cut, will their global impact be much greater than the pre-QE period and greater than non-synchronised rate cuts because they still have such inflated balance sheets?

“That’s certainly a danger in our view and one reason why central banks should be cautious in their actions and not deliver as much in the way of rate cuts as the market is currently pricing," said Mr. Steve Barrow.