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Central banks have cut interest rates prematurely

European Central Bank President Christine Lagarde speaks at a rates decision news conference in Frankfurt yesterday. Credit: Getty

June 7, 2024 - 5:30pm

On Wednesday, the Bank of Canada cut its target interest rate for the first time in four years. Then, yesterday, the European Central Bank followed suit. Despite both central banks warning investors not to read too much into these moves, markets still ran with the narrative that the days of easy money were finally returning. The bond-market rally already underway picked up speed, and long-term interest rates across the developed economies sank to multi-month lows as traders anticipated further cuts.

Spurred on by the lure of cheap credit, stock markets then set new highs. Bitcoin, which arguably can be seen as a betting market on the future direction of monetary policy, started heading towards the record levels it set earlier this year. Keith Gill, a “finfluencer” who goes by the name Roaring Kitty, triggered yet another meme-stock rally in GameStop shares by saying he’d post a livestream today at noon.

But this morning the US jobs report came out, and the mirrorball crashed to the dance floor. Not only did the number of new jobs created in the American economy surge past expectations, but hourly wages remained strongly positive. Bond yields shot back up as investors sold Treasuries, ending the party. Markets lost their vigour. At the open of trading, GameStop shares plunged by nearly a fifth.

There was already an inkling of what was coming in the previous day’s productivity report, which revealed American unit labour costs to still be rising strongly. In short, the US economy is still strong and inflationary pressures remain present, which ensures the Federal Reserve won’t be joining any rate-cutting cycle in the near future.

For President Joe Biden, the report was a mixed blessing. On one hand, jobs abound and real wages continue rising, which will improve his re-election prospects. On the other, mortgage and credit-card rates won’t be coming down soon, which will hit the disposable incomes of the voters he needs to win over.

Still, it constitutes better news for him than it does for governments and central banks elsewhere. All the US’s major partners are struggling to regain economic momentum. The problem they each face is that while their own inflationary pressures are easing sufficiently to permit rate cuts, high interest rates in the US will prevent them from going very far with it.

The higher rates on offer in the US will lure money stateside from those economies. That will diminish the value of their currencies, raising import costs and thus refuelling their inflation. Meanwhile, bond investors looking for higher returns will sell other G7 bonds to buy US Treasuries — not only because they’ll offer better returns, but because a strengthening dollar will improve the value of their investments in their own currencies. And as they sell Canadian, European or British bonds, the yield on those instruments will rise, driving interest rates back up.

This tug of war between central banks and investors will continue until one or the other side taps out. Fed Chairman Jerome Powell keeps signalling that better days are coming but then the data keeps coming along and making him look like he’s jumped the gun. It’s now looking increasingly likely that any easing by central banks in the coming months will be limited and tentative. Meanwhile, the activity in bond markets, which is what ultimately determines long-term rates such as mortgages and car loans, is for now counteracting the moves by central banks.

Bond yields in Canada and Europe actually ended the week above where they were before their central banks cut short-term rates. It doesn’t look like things will change anytime soon.

John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).


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Santiago Excilio
Santiago Excilio
10 days ago

Ha ha.
The ECB has fluffed it (again) and Europe will pay the price. Inflation is not back in the bottle in fact it is going to get worse because it’s actually baked in via EU obsessions with net zero, climate change, GM crops and nitrate legislation, so it will keep going up because consumers are going to be forced into consumption decisions that in a normal ‘free market’ they simply wouldn’t make.
So prices will go up, and the European currencies will devalue as the interest rates are cut. But oops, the US figures show inflation and job creation surging so no rate cuts there on the immediate horizon, in the worlds reserve currency, in which the majority of global commodities contracts are priced, commodities like LNG on which Europe is massively dependant and is importing from, er, the US. “But it will make exports more competitive” cry the optimists – what exports? Things like solar panels, batteries and electric cars – things EU consumers are going to be forced to buy? Er no, those all come in a huge tidal wave from China (priced in dollars), not from the great horde of EU zombie companies whose operating profits barely cover their interest burden; lower rates might allow them to continue to limp on, suppressing productivity and driving wage inflation without delivering genuine growth . . . a perfect recipe for stagflation.
The UK might look pretty desperate at the moment, but I can assure you that the grass is certainly not greener in the Eurozone, nor is it likely to get so any time soon.

Pedro the Exile
Pedro the Exile
9 days ago

Excellent & spot on.When the ridiculous and perma tanned old wrinkly Ms Lagarde announced earlier that the ECB were cutting rates you could have placed a bet on the US data coming in strong.The debt laden European economies are desperate for cheaper rates to kick the can down the road but the Fed won’t oblige.This will go on for some time yet with “investors” calling for cuts the Central Banks unable to deliver.Get used to it-higher rates are here for a while yet.

Last edited 9 days ago by Pedro the Exile
Susan Grabston
Susan Grabston
10 days ago

The tug.of war is between.Powell.and Yellen. He’s stuffed as long as she keeps monetising the debt.