Today, January 29, big, surprise interest rate increases from central banks in Turkey, India and South Africa didn’t stabilize global markets. A decision on Wednesday by the Federal Reserve’s Open Market Committee to reduce its monthly buying of Treasuries and mortgage back securities by another $10 billion a month added to the downward bias. The U.S. Standard & Poor’s 500 fell 1.01%. The German DAX slipped 0.57%. Among emerging markets the Turkish stock market dropped by 2.29% and stocks retreated 0.59% in Brazil. In Asia Japan’s Nikkei 225 was down 3.33% as of 10.40 p.m. New York time.
If the Turkish central bank thought a huge interest rate increase would shock and awe investors, it was disappointed. After avoiding an actual interest rate increase in the face of pressure from the government, Turkey’s central bank used an emergency meeting to raise its benchmark seven-day repo rate to 10% from 4.5%. The move is intended to 1) restore confidence in the central bank, 2) stop a run on the Turkish lira, and 3) reduce an inflation rate running at 7% and threatening to move higher. The lira was down 30% against the U.S dollar in the current rout and it now trades at a record low against the U.S. dollar.
The Reserve Bank of India also raised interest rates yesterday with an increase in the benchmark rate to 8% from 7.75%. Inflation in India has been running near 10% and the country’s reliance on cash flows from overseas to balance its current account deficit has kept pressure on the rupee.
South Africa joined the interest rate parade yesterday with the South Africa Reserve Bank hiking its benchmark repurchase rate to 5.5% from 5%. The increase was the first for the bank since 2008. Inflation in South Africa climbed to 5.4% in December. The rand is down 6.8% so far in 2014.
The problem with interest rate increases like these is that they’ll only work to stabilize financial markets and currencies if 1) investors and traders think the most recent move is the last or near the last in a series of interest rate increases, and 2) if investors and traders find the rates on offer compelling enough to turn cash outflows (into dollars) into cash inflows (into lira, rupee, and rand.) On the evidence of today’s market moves, these recent central bank actions don’t meet either test.
I’d expect that the emerging market—and developed market too—retreat will continue tomorrow. Overnight the second read on China’s manufacturing sector from the HSBC/Markit Economics purchasing managers survey showed the sector contracting with a reading of 49.5, down from 50.5 in December. Any number below 50 indicates that the sector is in contraction. (The official government survey of purchasing managers is due on February 1.)
I think that data will just feed into worries that China’s economy will slow to a growth rate below the 7.7% annual rate reported for the fourth quarter. And those worries are a key driver in the current sell off in emerging and developed markets.
The central banks of Mexico and Colombia are scheduled to meet on Friday. There’s a good chance that they won’t join the interest rate increase parade. That might do more to stabilize markets than today’s round of interest rate increases.
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