US Fed hike causes gyrations in financial markets

AS CENTRAL banks do battle with the worst inflation for a generation, they are putting the easy-money policies of the past decade into reverse. On May 4 the Federal Reserve raised interest rates by half a percentage point and announced that it would soon shrink its portfolio of bond holdings. The Bank of Australia, which not long ago was predicting it would keep rates near zero until 2024, surprised investors by increasing them on May 3 by a quarter-point. The Bank of England is expected on May 5 to raise rates to their highest level since 2009.

Though share prices jumped a little after the Fed’s rate rise—in apparent relief that it is not tightening faster still—financial markets have been adjusting painfully to the reality of tighter money. Global stockmarkets fell by 8 per cent in April, as investors priced in higher rates and lower economic growth. Financial markets are adjusting painfully to the reality of tighter money. On May 2 America’s 10-year Treasury yield, which moves inversely to prices, briefly hit 3 per cent, nearly double its level at the start of the year.

One consequence of tightening financial conditions is a big repricing of currencies. The dollar is up by 7 per cent against a basket of currencies over the past year. America needs higher interest rates than any other big rich economy, because of its overheating economy and labour market. Higher rates increase investors’ appetite for dollars, adding to dollar-demand caused by a fall in their desire to take risk elsewhere as war rages in Ukraine and China battles an outbreak of coronavirus. Most striking has been the greenback’s appreciation against the Japanese yen, the only currency of a big rich country in which interest rates look unlikely to rise soon. In real terms the yen is at its cheapest since the 1970s.