Powell’s actions have caused an avalanche of money to flee the shores of other countries to safer American investments that offer a much more attractive return because the US now has its highest interest rates since 2008. A stronger dollar means the cost to Europeans of heating their homes. and the energy supply to its cities, already boosted by the Russian invasion of Ukraine, is increasing. And smaller developing countries could start drowning in increasingly onerous debt payments.
Fed officials are in regular communication with their counterparts in other countries, and Steven Kamin, who led the Fed board’s international finance division through 2020, said Powell and his fellow politicians will hear a lot of anxiety from foreign officials. about the consequences caused by central bank policies.
“Will that stay the hand of the Federal Reserve? Probably not,” said Kamin, now a senior fellow at the American Enterprise Institute. “They are quite focused on inflation.”
Most central bankers are also locked into their own fights against inflation, so they understand the Fed’s resolve; in fact, price stability in the US also benefits the rest of the world. But with a global recession looming ever greater, one of the biggest risks hanging over the Fed’s actions is that other central banks could soon feel the pressure to cut rates as their economies contract. However, it will be more difficult for them to do so, because that would drive even more valuable capital into US markets.
“We could enter a phase where we run the risk, just because of the fear of financial volatility, of going against the Fed,” said Alejandro Werner, a former Mexican government official and the International Monetary Fund. “Central banks in Latin America and other emerging markets could be much more cautious in relaxing their monetary policy stance and injecting some additional recessionary forces.”
Europe, like the US, has faced high price spikes for decades. Preliminary data from Germany showed annual inflation hit 10 percent in September. But the European Central Bank has been coy compared to the Fed.
That’s because the ECB, led by Christine Lagarde, is facing inflationary pressures strongly driven by factors that monetary policy can hardly influence. Lagarde said on Wednesday that 60 percent of the rise in inflation in the eurozone can be attributed to energy, an intense side effect of the Ukraine war. By contrast, prices are rising in the US in part because government and consumer spending have been so strong.
And while the ECB has taken a significantly tougher line on inflation of late, investors fear a potential recession could stop the central bank in its tracks. The war in Ukraine is driving up energy import prices and is also expected to leave a deep mark on growth.
In the worst case, widespread blackouts could cripple the region’s industry. Dire economic prospects may hamper the need and preparation to push borrowing costs much higher. While Fed interest rates are forecast to peak at 4.3 percent next year, markets are betting the ECB’s will fall short of 3 percent.
The last two periods of dollar highs ended with coordinated efforts by the US and other countries to intervene in the value of the currency, sparking speculation that it could once again be an option. But there is little evidence that such an agreement is in the offing.
“I don’t anticipate that that’s where we’re headed,” White House National Economic Council director Brian Deese said at an event Tuesday night.
Still, when world policymakers gather for the IMF and World Bank annual meetings next month in Washington, close attention will be paid to the extent to which the US and its allies affirm their commitment, most recently signed in May of this year, to allow the value of their currencies to be fixed by the markets.
The Fed’s moves have already prompted the Bank of Japan to move in the currency markets. BOJ Governor Haruhiko Kuroda and his fellow central bankers last week left interest rates in sub-zero territory and said they have no plans to raise them any time soon. But Japanese authorities also took unexpected steps, after the Fed raised rates by another three-quarters of a percentage point, to prop up the value of the yen, a move the US Treasury Department has made clear it is watching. closely, but did not come to condemn.
“We understand Japan’s action,” a Treasury spokesman said in a statement, adding that the United States was not involved in the move.
A key question is what kind of pain abroad would be enough to prompt US policymakers to change course and seek more concerted policies to ease the burden on other countries, such as debt relief through the IMF.
“Certainly if we get to the point where there are cascading defaults in emerging market countries that are contributing to global financial stress, that’s what starts to get at least some attention,” said Tobin Marcus, senior policy strategist and Evercore ISI politician, who previously advised then-Vice President Joe Biden. “But even so, things would have to be pretty bad along that vector to see the kinds of spillover effects that would inevitably come to the attention of policymakers in the US.”
Instead of working together to steer currency markets, global central banks might also consider coordinating interest rate hikes to avoid driving borrowing costs too high, Peterson Institute fellow Maurice Obstfeld argued in an article. recent.
Still, for the Fed, those decisions will be primarily driven by the extent to which they threaten the US economy. The central bank is tasked with seeking both price stability and maximum employment, said Simon Johnson, a professor at the MIT Sloan School of Management and a former IMF chief economist.
“There is nothing in his mandate about anything global,” he added.