Fed tightening deepens monetary policy rifts worldwide

Subject

US tightening continued this month despite lower inflation expectations.

Significance

Monetary policy rifts have deepened since the decision by the Federal Reserve (Fed) on June 14 to raise interest rates for the second time this year despite inflation easing and oil prices falling below 45 dollars per barrel. Growing discord between central banks and bond markets has spread to the Bank of England (BoE), where three of the eight committee members disagreed with the June 15 decision to keep rates on hold despite inflation spiking to its highest since June 2013. The ECB and the Bank of Japan (BoJ) are also under pressure to set out plans to wind down their quantitative easing (QE) programmes.

Impacts

• ‘Reflation trading’ continues to unwind; the world stock of negative-yielding government bonds has surged to nearly 10 trillion dollars.
• US equity markets are hovering near records despite a plethora of vulnerabilities, including lower oil prices and rising political risks.
• Emerging markets (EM) inflows continue to surge, but higher US rates may force EMs to raise rates before they are ready, hitting activity.
• The divergence between rising US rates and ultra-loose ECB and BoJ policy will cushion the dollar, protecting it from rising US risks.