THE past month witnessed the most volatile financial market since the March 2020 Covid pandemic-triggered meltdown. For September, Dow Jones Industrial Average was down 9.2 percent or nearly 3 000 points, while the US dollar reached a 20-year high on September 26 with the dollar exchange rate index (DXY) at 114. The dollar ended the month at DXY 112.17, an appreciation of 3.2 percent in a month and almost 17 percent from the end of 2021.
The dollar’s strength affects many other currencies, and the peso was hit hard. The exchange rate dropped 4.4 percent in a month and more than 15 percent year-to-date. The Philippine Stock Exchange Index ended at 5741.07, down more than 14 percent for the month. The latest inflation forecast was raised to 5.6 percent by BSP, above from the earlier full-year target of 2 to 4 percent.Bank of England Governor Andrew Bailey, Australia Reserve Bank Governor Philip Lowe, Bangko Sentral ng Pilipinas Governor Felipe Medalla, Finance Secretary Benjamin Diokno, and German banker Nathan Rothschild
The September volatility was triggered by the release of the US August CPI. The 8.3 percent figure was lower than the 8.5 percent in July, but its composition indicated that the inflation drivers have shifted to two more sticky causes. The earlier judgement that the supply chain disruptions from the Covid pandemic lockdown and energy price hike from the Russia-Ukraine War precipitated this round of inflation is proven wrong. Analysis of the inflation drivers shows that service price increases from labor wage spiral and rent increases from abnormal housing price surge are the drivers. They are sticky and raise questions over when inflation will subside.Get the latest news delivered to your inboxSign up for The Manila Times’ daily newslettersBy signing up with an email address, I acknowledge that I have read and agree to the Terms of Service and Privacy Policy.
Most pundits now raise estimates over the current rate cycle for the US to the Fed Fund rate of 5 percent, and tapering to start later in 2024. The dollar’s central role in the global financial market means the inflation and interest rate outlook has darkened everywhere.
Understanding the interest rate and exchange rate impact on the global financial market, many pundits posited that the financial market in October could be volatile. Two other news somewhat reinforce the belief.
Record loss at Reserve Bank of Australia
The Reserve Bank of Australia (RBA) announced on September 21 that it had taken a mark-to-market valuation loss on its bond holding of AU$44.9 billion (US$30.02 billion) in 2021/2022. The bonds were accumulated under a AU$300 billion emergency stimulus programme from November 2020 to February 2022.https://geo.dailymotion.com/player/x7y6v.html?video=x87fnq0&customConfig[customParams]=custom&actionInfo=false&mute=true&dmPubtool=customembed-v2
The losses eclipsed underlying earnings of AU$8.2 billion and left the central bank with an accounting loss of AU$36.7 billion. The accounting loss wiped out the equity of RBA, and it is in a negative equity position of AU$12.4 billion.
All central banks in the world have their liabilities guaranteed by the government, and its legal power to create money means RBA operations will not be affected. However, the accounting loss still constrains the ability of RBA to pay a dividend to the government in the immediate future and likely deter it from further government bond monetization.
With the rising interest rate, many central banks worldwide would face similar losses on their emergency stimulus programmes. In July, the Swiss National Bank reported a first-half loss of 95.2 billion Swiss francs, the biggest since the central bank was founded in 1907.
Bank of England steps in to buy long-dated bonds
The sterling dropped to a historic low of $1.04 per dollar after the government announced a mini-budget that cuts tax rates without offsetting budget measures on September 28. The budget got an unsolicited public pushback from the IMF, and rates on the UK bonds (gilts) shot up sharply. As a result, the Bank of England (BOE) was forced to step in to buy the long-dated bond to save the pension funds from mark-to-market induced insolvency when rates go up. The total commitment to buy 65 bilion pounds at a rate of 5 billion pounds daily until October 14 while postponing sales of gilts is unprecedented and shocking.
Moving away from low-rate takes time
The world has been living in a low-interest rate environment for some time since Quantitative Easing (QE) was adopted to solve the Global Financial Crisis in 2008; all investment and spending decisions were anchored on low-interest rate assumption with the pledge of the major central banks to keep inflation at 2 percent serving to underpin the low rate promise. However, the inflation upsurge forced the central banks worldwide to raise rates, which upset the earlier economic equilibrium. The RBA and BOE story highlights the limitation of the central banks once the market is turning around. The economy takes time to reach a new economic equilibrium, and October is likely another month for the world economy to search for a new balance.
The months of September and October hold special meaning to financial watchers as these months are often associated with financial volatility and crisis. The Great Depression was triggered by the Wall Street Crash of October 1929, and the key precipitating factor of the 2008 Global Financial Crisis was the Lehman Brother collapse in September. In addition, the two months are often the weaker months of the year in the US and many other equity markets.
Dr. Henry Chan is an internationally recognized development economist based in Singapore. He is also a senior visiting research fellow at the Cambodia Institute for Cooperation and Peace and adjunct research fellow at the Integrated Development Studies Institute (IDSI). His primary research interest includes global economic development, Asean-China relations and the Fourth Industrial Revolution.
A similar version was published in Manila Times on October 2 2022. We welcome logical feedback and possibly working together with compatible frameworks. (idsicenter@gmail.com)
