Opinion | US Fed and other central banks can’t tighten monetary policy much more

Nicholas Spiro says the economic indicators are all showing that monetary tightening won’t be possible for much longer, despite the recent spate of Federal Reserve rate hikes

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US Federal Reserve chairman Jerome Powell attends a G20 finance ministers and central bank governors’ group photo on the sidelines of the IMF and World Bank spring meetings on April 20 in Washington. Photo: Bloomberg

Published: 1:45pm, 23 Apr 2018Updated: 9:47pm, 3 Jul 2018

Ever since the Federal Reserve rattled financial markets in May 2013 by announcing its plans to scale back its programme of quantitative easing, bond investors have been speculating incessantly about the timing and pace of a withdrawal of monetary stimulus by the world’s leading central banks.

The Fed, which raised its benchmark interest rate last month for the sixth time since December 2015 and forecast sharper-than-expected increases in the coming years, is the most advanced in normalising policy.

According to market-derived probabilities of further tightening, the US central bank is almost certain to lift rates another two times this year, with the chances of three more hikes having shot up to 30 per cent, up from 10 per cent at the start of this year.

Such is the extent of the perceived divergence between a hawkish Fed and a much more dovish European Central Bank (which, like its Japanese counterpart, is still pursuing quantitative easing as the euro zone’s underlying inflation rate remains at just half of the 2 per cent target of the ECB) that the spread, or gap, between the yield on 2-year Treasury bonds and its negative-yielding German equivalent has surged to nearly 3 per cent, its highest level since the launch of the euro in 1999.

European Central Bank president Mario Draghi (centre) talks to Deutsche Bundesbank president Jens Weidmann on the sidelines of the spring meetings of the International Monetary Fund and World Bank in Washington on April 20. The IMF said this week the world's debt load has ballooned to a record US$164 trillion, a trend that could make it harder for countries to respond to the next recession and pay off debts if financing conditions tighten. Photo: Bloomberg