Illustration copyright Gennady Safonov/TASS
The US Federal Open Market Committee on Wednesday raised its benchmark rate by 0.25 percentage points to a range of 1.25-1.5%. The American central bank is thus gradually tightening its monetary policy.
This is the latest rate hike under current Fed Chair Janet Yellen, followed by Jerome Powell early next year.
Experts expect that he will continue to tighten monetary policy: during the 2008-2009 crisis, the American central bank cut rates to almost zero, and also carried out large-scale asset purchases using newly printed money (these operations were called “quantitative easing”, or QE).
Just a few years ago, the Fed’s policy largely determined the state of global financial markets: flows of money from the American central bank flowed into developing countries, leading to the growth of their markets and strengthening currencies, and also contributed to rising oil prices after the 2008-2009 crisis. The first steps to tighten monetary policy in 2015 led to a fall in markets.
Now the influence of Fed policy has noticeably decreased. The BBC Russian service looked into how the Fed's rate hike will affect the ruble, the Russian market and oil prices in the long and short term.
Why won't markets fall after the Fed's decision?
"Markets have already priced in the Fed's rate hike," Renaissance Capital economist Charles Robertson told the BBC.
The same is stated in the report of the investment division of Sberbank (Sberbank CIB): “the increase in rates has already been fully appreciated by the markets and in itself will not lead to any market reaction.” According to the bank's analysts, the market's reaction will depend on the Fed's forecasts for 2018 - the regulator usually gives a signal about how rates will rise next year.
The market now assumes that the Fed will raise rates 2-3 times next year, Robertson explains. Emerging markets may react if the Fed gives a signal that next year they will raise rates by 3-4 times, the economist explains.
The change of the head of the Fed limits the significance of any assessments, Anton Tabakh, chief economist of the Expert RA agency, disagrees. After a series of new appointments, the dynamics of rate increases may change, he explains. At the beginning of next year, there will be a number of personnel changes at the Fed: not only the head of the Central Bank will change, but also a number of high-ranking officials of the American central bank.
Why does the Fed's policy have less and less impact on emerging markets and Russia?
Fed policy, according to Tabach, has less impact on emerging markets than before, and for other reasons: the investor base in emerging markets has become broader.
This year, the Fed has raised rates three times: at the beginning of the year, the rate was only 0.5-0.75%. Markets in developing countries are growing much faster than those in developed countries. Thus, the MSCI index for developing countries grew by almost 27.7% in 2017, while the British FTSE 100 index added only 7.7%, and the American S&P 500 - 17.5%.
Economists in various reports explain the growth of emerging markets by the acceleration of their economies, for example, the growth of the Russian economy accelerated, and in the middle of the year, many experts, although only slightly.
Tabakh also names another reason: Fed policy changes have become more predictable. They are announced in advance, and investors can “build them into the price,” the economist explains.
The Fed sets rates for the US economy, but the regulator is also concerned about how its actions will affect confidence in global markets, Sberbank CIB chief strategist Tom Levinson explained to the BBC. "US rates are rising, but the gradual rise in rates is supporting emerging markets," the economist explained. Levinson does not see that rising rates can somehow affect the ruble exchange rate.
"The Fed's policy remains soft. This softness means that a lot of money is distributed around the world, including Russia," Robertson adds. According to him, Fed rates, even after the increase, are still significantly below the combined level of economic growth and inflation.
Will rising rates in the US affect the ruble and oil?
The ruble exchange rate in recent months has actually become untied from oil prices, experts and ministry officials economic development Russia. One of the reasons for this is carry trade operations - when investors make money on the difference in interest rates in different countries. They borrow currency from a country with low interest rates, like the United States, and buy currency from a country with high interest rates, such as Russia. And then they invest the money in bonds, which brings additional income.
“Carry trade will inevitably decline on both sides - from rising rates in the United States and from their reduction in Russia,” explains Anton Tabakh.
“Most likely, we will not see a strengthening of the ruble next year; most likely, there will be a weakening,” he believes.
Both Tabakh and Levinson noted that the oil market is almost now independent of the Fed's policy. “Oil prices are now determined by supply and demand factors in the energy market,” explains Levinson from Sberbank. This essentially means that the Fed's policies will not affect them.
Following the meeting of the Open Market Committee, the Federal Reserve expectedly increased the base interest rate in the United States by 25 bp, to 1.75-2%. The American regulator explained the decision by the fact that the country's economy and economic activity are demonstrating steady growth rates, and the labor market continues to strengthen. “Family expenses increased, while investment in fixed assets continued to grow,” the communiqué from the Committee meeting noted.
Still, Fed Chairman Jerome Powell noted that “concerns about changes in trade policy are growing. We're starting to hear about this from companies that are delaying investment and hiring."
The Fed also emphasized that the country's monetary policy remains accommodative. The Committee is targeting inflation at 2% and, judging by the statement of Federal Reserve Chairman Jerome Powell, is not afraid of its reduction. The Fed is expected to raise rates two more times by the end of this year. Next year, the Fed is scheduled to raise rates three times.
Height key rate The Fed means an increase in prices for goods and services in the medium term, says Georgy Vashchenko, head of the operations department on the Russian stock market at Freedom Finance Investment Company. Loans in the economy will become more expensive. But the effect on the American economy and other countries will be different. Rates are low in the US right now, and international banks are funded in the US whenever possible. Producers of commodities in Russia, Saudi Arabia and other countries prefer to borrow in dollars, since their revenue is in dollars.
The cost of their production will increase due to rising costs of equipment and servicing loans, and profitability may decrease due to competition with American manufacturers. Oil production in the United States is growing, it has already reached almost 15 million barrels. per day, an increase of 12% compared to last year.
How can one not understand?
For Russia, as for other countries, a rate increase in the United States has more negative consequences than advantages, says Georgy Vashchenko. Russia has a lower investment rating, higher inflation and more risks, which is associated with the volatility of commodity prices, dependence on foreign markets sales and capital raising. Accordingly, investors want to receive O higher profitability compared to dollar instruments.
The Central Bank is forced to maintain rates on high level to ease the pressure on the ruble. And a rate above 6% hinders economic growth. Despite the rise in oil prices to almost $80 per barrel and the relative stability of the ruble, as well as low inflation, GDP growth this year will probably be less than 2%, Georgy Vashchenko expects. Russia is among the laggards among the group of BRICS countries. The Central Bank will most likely leave the key rate unchanged on Friday.
In general, the Fed’s increase in the reserve rate is a long process that can be observed in the last few years, recalls, in turn, CEO IC "Kharitonov Capital" Maxim Kharitonov. The American economy is actually doing well, mainly as evidenced by rising inflation and falling unemployment. This is quite logical after the extensive quantitative easing (QE) programs, which by historical standards ended quite recently, and consisted, in simple terms, of pumping money into the economy through the mechanism of money emission.
According to the analyst, this mechanism is inertial, it has accelerated quite strongly, raised the prices of many assets, and therefore now the Fed is starting to slowly, carefully stop it so as not to overheat the markets. Increasing the reserve rate is one of the methods of slowing down the economy, if we speak in simple words, it makes borrowed money more expensive, which means it reduces the appetite of firms and investors for rapid growth and the risk that accompanies such growth.
What is important for markets is not only today’s specific rate increase, but also the fact that there may be two more such increases this year. That is, the rate could reach 2.5% already this year. And also that in 2019 the rate may be raised 3-4 more times. And we can assume that by the end of 2019 it will grow to 3.5-3.75%. At this rate level, international investors will be inclined to invest in American companies and their securities, especially given Trump's tax reform and new tariffs on raw materials that should give American producers an advantage.
This trend means, explains Maxim Kharitonov, that money that were there before invested in developing markets, will go from there to the US market, as well as the EU. For the ruble and ruble assets, unfortunately, this means the prospect of loss of interest from international investors and speculators. The smaller the spread between the Central Bank key rate (7.25%) and reserve rate FRS (1.75-2%, and in the future - 3.5-3.75%), the less attractive carry trade operations supporting the ruble are. With the Fed rate increase, according to Kharitonov, the ruble will fall lower and lower against the dollar. By the end of 2018, you can expect 68-69 rubles per dollar, and in 2019, it will go beyond this range, to 73-75 rubles.
At 25 b. for the first time since the global financial crisis in 2008.
We explain what the Fed rate is, how it changes and why it affects our lives.
What is the base rate?
This is the interest rate at which U.S. banks lend their excess funds to other commercial banks.
The Federal Open Market Committee sets the so-called federal funds target rate, which is a value or range of values - the same 1.75-2% per annum. The weighted average of the rates is called the federal funds effective rate.
What does the rate change mean?
Lower interest rates lead to higher levels of consumption as well as greater investment. And vice versa: the higher the rate, the more expensive the loans and the less money there is in the economy. This means that the demand for them is growing, which means that the value of the dollar is also growing. That is, the Fed’s decision to lower the rate means a softening of US monetary policy: money used to be expensive, but now it will become cheaper.
Following the American regulator, other global regulators often reduce their rates. For example, central banks of the Gulf countries, etc.
Why did the Fed cut rates?
The Federal Reserve base rate is one of the main instruments of US monetary policy, which allows, if necessary, to reduce the “overheating” of the economy (if the rate is raised) or, conversely, to stimulate its growth (if it is lowered).
Fed Chairman Jerome Powell explained that the regulator decided to lower the rate just to maintain the pace of economic growth and hedge against risks. At the same time, the basic economic forecast remains favorable. And when lowering the rate, everything that could affect the country’s economy was taken into account, including trade wars.
Powell also stressed that he does not expect a recession in the US economy, which has been talked about so much lately.
What are the consequences of a rate cut?
Since the United States is the largest economy in the world, its main indicators and the Fed's measures to adjust them have a strong impact on world exchanges and the currencies of other countries. Thus, low rates in the United States and Japan in the short term will make the currencies of emerging markets (which include Russia) more attractive for investors - highly profitable, but at the same time more risky. Actually, when the rate increases, everything works the other way around.
A downward revision of expected interest rate paths in the US and eurozone, as well as a cut in the US Federal Reserve's base rate in July, along with softening rhetoric from the US Federal Reserve and the ECB, reduce the risks of significant capital outflows from emerging markets, the Russian Central Bank noted in a recent report on monetary policy. credit policy.
Oil prices are inversely related to the US currency: the cheaper the dollar, the more expensive the oil. This is due to the fact that global oil contracts are denominated in American dollars. Thus, a reduction in the Fed rate should lead to a rise in the price of a barrel. But in to a greater extent Oil prices are determined by supply and demand factors in the energy market. Now the main one of these factors is the speed of restoration of oil production in Saudi Arabia after.
What to expect next?
When Jerome Powell cut rates in July, he warned that this did not signal the start of a monetary easing cycle. But already in September he said that the agency could continue to reduce the rate for a long time if the growth of the US economy slows down significantly. However, there are no such forecasts yet.
On the contrary, the financial regulator “sees favorable economic prospects with continued moderate economic growth, a stable labor market and inflation around the target of 2%.” The department believes that the American economy will continue to grow at a moderate pace at least until the end of next year.
Experts believe that the Fed will cut rates at least once more in 2019. And some analysts even suggest two reductions this year, and two more next year.
What does Donald Trump think about the bet?
Even during the presidential campaign, Trump established himself as an opponent of the regulator’s monetary policy then pursued. In an interview with CNBC, he said that as a businessman he likes the low rate, but for the good of the people it needs to be raised. After his election, Trump changed his position and not only stopped criticizing the Federal Reserve, but also thanked its head for his good work.
The favor did not last long - in 2018, the American leader again began to criticize the Fed for raising the base rate. This prevented him from carrying out his ambitious economic program. During the election campaign, Trump promised to launch a number of large-scale programs, lift restrictions on and increase budget spending to support economic growth. All this threatened to accelerate inflation and create dangerous financial bubbles, so the Fed's task was to balance the president's plans with a tighter monetary policy.
Now Trump has cut the base rate for the second time in a year, but advised the Fed to act faster. "I think they made some mistakes," Trump said. According to his version, the financial regulator “raised [the rate] too quickly and lowered it” by a very small amount. Moreover, immediately after the Fed announced its decision, the head of state attacked it and its head with criticism
The US Federal Reserve System (FRS) on Wednesday, December 19th last time will make a decision on the base interest rate in a year. According to analysts surveyed by Forbes, the Federal Reserve will raise rates, as the market expects, despite a noticeable drawdown in the American stock market.
Based on the values of futures for fed funds rates, it is highly likely that the rate will increase at the December meeting, explains investment strategist at BCS Premier Alexander Bakhtin.
The market has set a scenario for an increase in the rate by 25 basis points to 2.25-2.5% per annum, and all current macroeconomic data from the United States indicate that the Fed will not take another pause in tightening monetary policy, says Aton’s leading strategist Andrey Kaminsky.
In November, US unemployment remained at 3.7%, the lowest level in almost 50 years, and inflation was 2.2% in annual terms - even higher than the Fed's target of 2%.
Even the emerging correction in the American stock market will not stop the Federal Reserve. Since December 13, all major US indices have shown strong declines: the S&P 500 fell by 4%, the Nasdaq by 4.7%, and the Dow Jones 30 by 4%.
Since the American regulator, when making a decision on the rate, relies on the dynamics of macroeconomic indicators, it has no reason yet to change course due to a fall in quotes, Igor Klyushnev, head of the trading operations department of Freedom Finance Investment Company, is sure.
What will happen to the market and the dollar?
The rate increase is an expected decision, and current securities quotes have already reflected its impact, says Klyushnev. “The decline in indices may temporarily intensify after the publication of the Fed decision, but it will not last long,” says the financier.
For investors, the statements made by Federal Reserve Chairman Jerome Powell will be more important. Analysts expect the rhetoric to soften and hints at a slowdown in rate increases.
The receipt of such signals will have a positive impact on the American market and may lead to an increase in quotes, but at the same time weaken the dollar exchange rate against major world currencies, Klyushnev notes.
If the Fed tightens its rhetoric - and such a scenario cannot be ruled out - the market is in for a difficult time. “The United States has set a course for strengthening the dollar, attracting capital from developing countries and increasing the yields of its debt securities, so a gradual increase in rates is what is needed to achieve both economic and political goals,” says Alor Broker analyst Alexey Antonov.
In his opinion, after the rate increase, the S&P 500 index will continue to decline to a level of 2,400 points, the euro-dollar pair will tend to the value of 1.1 over the six-month horizon, and towards parity over the next year, if the current Fed policy is maintained.
Impact on Russia
If the Fed's rhetoric softens positive sentiments American investors will gradually spread to other capital markets, including the Russian stock market, says Anton Kostin, asset manager of Sistema Capital Management Company.
The Fed's policy may ultimately affect the ruble exchange rate and the yield of Russian securities. “The rise in rates in the United States is forcing the Russian Ministry of Finance to raise the OFZ yield in order to restore the narrowing gap between the yield of bonds in dollars and in rubles. A decrease in the difference between ruble and dollar yields would be a signal for foreign investors to sell OFZs, and this would lead to a sharp weakening of the ruble,” explains Igor Klyushnev.
According to the analyst, the Fed’s decision will not in any way affect future decisions on the Central Bank’s key rate. “On December 14, the Bank of Russia raised the rate in advance, even before the Federal Reserve meeting, so as not to provoke an outflow of investors from the OFZ, since it is known that the Federal Reserve is highly likely to raise the base interest rate. However, after the Fed meeting, actions to change the key rate will not be required,” explains Klyushnev.
However, if the Fed rate hike cycle continues, the dollar will strengthen, and the ruble exchange rate will see a noticeable decline. According to Alexey Antonov, the dollar to ruble exchange rate will exceed the 70 ruble mark before the new year, and after the Christmas holidays the fall of the ruble may intensify.
Since the end of 2015, the US Federal Reserve has begun normalizing monetary policy. The essence of this process is to bring the level of the effective federal funds rate to a sustainable level. long term level (now estimated at approximately 4%), and also remove from its balance sheet the excess assets that the regulator acquired as a result of the quantitative easing program.
In December 2015, the rate was increased for the first time in 11 years by 0.25 percentage points. from near zero level. Next time increase interest rate happened only a year later - in December 2016, with a shift to the level of 0.5-0.75%. This year, the process of normalizing rates has accelerated, and two increases have already occurred - both of 25 basis points, and following the results of the December meeting, which will end on December 13, the interest rate is highly likely to be increased for the third time.
Why does the Fed raise rates?
Fed officials continue to argue that the rate hike is linked to expectations that inflation will rebound in the United States as the economy grows. Now the regulator is pursuing a policy to protect against a possible surge in inflation in the coming months due to the introduction of tax reform, which involves a significant reduction in the tax burden on business.
Tax reform in the United States is a key driver of high “risk appetite” in global stock markets: its implementation will accelerate US GDP growth next year to 2.0%-2.4% and accelerate inflation dynamics. In addition, the impact of Donald Trump’s presidential program on the economy in 2018, if it extends over 2-3 years, is estimated at 0.6%-0.8% of GDP, since part of the stimulus will most likely be used to repay debts and leveling out the slowdown in current growth rates. Against this background, the Federal Reserve is in a hurry to raise interest rates in order to create a basis for easing business conditions in the event of the loss of growth momentum and the US economy moving towards recession.
In February 2018, the post of head of the Fed will pass from Janet Yellen to Jerome Powell, but this will not change the direction of monetary policy in the United States. Although new manager The Federal Reserve has a more dovish outlook, with the market expecting at least two more rate hikes in 2018 to 2%.
Thus, by the end of next year the economy and financial markets may fall into an unpleasant trap: interest rates are rising, the Federal Reserve is determined to prevent inflation from rising above its 2% target within a year, while the US economy is not seeing much effect from tax reform and, according to forecasts, is gradually beginning to slow down in terms of GDP growth to 2 % - this level can be reached in the fourth quarter of 2018.
What should an investor do?
What are the dangers of raising the federal funds rate to 2%? The fact is that, provided that long-term inflation expectations remain at about 2%, a rise in interest rates has the greatest impact primarily on the short part of the curve, pushing LIBOR rates and Treasury yields with a maturity of up to two years higher. . As a result, by 2019, “short” rates may be higher than “long” ones, which will negatively affect the dynamics of the financial sector. This inversion of the curve is often called a harbinger of recession.
This situation may be exacerbated by a liquidity shortage in the banking system due to the fact that the Federal Reserve, in parallel with raising rates, has begun to reduce its balance sheet. From October, the volume of assets under management of the regulator will be reduced by $10 billion per month, while sales are expected to increase quarterly with the goal of reaching $50 billion per month.
At the same time, an increase in the US government budget deficit in connection with tax reform may have a positive impact on the state of the stock market, fueled by both a decrease in multipliers and the likely announcement of plans by the largest corporations to conduct a buyback and pay increased dividends.
However, the expansion of the budget deficit creates medium-term threats to the Treasury bond market due to the high dependence of the US budget on market attractions of government debt and capital inflows. So in the future, the US Treasury may face an increase in borrowing rates and an increase in the cost of servicing debt obligations.
Given the reluctance of the European Central Bank to rush to raise the key rate, as well as taking into account expectations for the US economy, the euro-dollar pair may fall to the range of 1.14-1.16 per dollar by the end of the year. However, by the middle of next year, the euro may well strengthen to 1.20-1.25 per dollar - economic processes are unlikely to allow the ECB to delay normalizing rates, and fiscal stimulus in the United States will be extended over time, which will significantly smooth out its impact on the American economy , which is in a mature growth phase.
Overall, the start of next year looks quite rosy for the stock and bond markets of both developed and developing countries. Risk appetite will be maintained at a high level, which will take stock indices to new highs, and inflows into high-yield assets can be converted into strengthening currencies of developing countries. The Federal Reserve's further monetary policy, which carries risks of curve inversion, may rather become a good reason for taking profits on risky assets in the second half of next year.