The View | Coronavirus recovery: why non-US central banks must protect countries from rates cycle

Name: Jacinda Ardern sweeps New Zealand elections, says voters endorsed her coronavirus response
Uploaded: 2021-03-29T14:00:11.000Z
Duration: 2 min 50 s
Description: Jacinda Ardern sweeps New Zealand elections, says voters endorsed her coronavirus response

The lessons of the ‘Great Bond Massacre’ of 1994 show how policy decisions made in the United States can have ripple effects around the world

US policymakers have the option of expansionary policy as part of their duty to look after their constituents, but its effects are not always benign

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US President Joe Biden meets with Treasury Secretary Janet Yellen in the Oval Office at the White House in Washington on January 29. Photo: Reuters

Dimitris Valatsas

Published: 10:00pm, 29 Mar 2021Updated: 10:00pm, 29 Mar 2021

US economic policy decisions have always had ramifications well beyond the country’s borders, and this year promises to be no exception. In 1971, US Treasury Secretary John Connally famously told a group of European finance ministers: “The dollar may be our currency, but it is your problem.”

Current Treasury Secretary Janet Yellen might be a more nuanced policymaker, but the central message still holds. The US makes its own fiscal and monetary policy, and it is quickly becoming the world’s problem. A contractionary global rate cycle is under way and global central banks need to act against this.

The American Rescue Plan Act signed into law by US President Joe Biden this month is projected to cost US$1.9 trillion, or roughly 9 per cent of US GDP, and it will be funded by new Treasury debt. This extra bond issuance, coupled with expectations of higher inflation and growth, has driven up government borrowing rates. Since the Georgia special election on January 4 delivered a Democratic majority in the Senate, the yield on 10-year government bonds has almost doubled from 0.9 per cent to 1.66 per cent.

But in financial markets, what happens in America does not stay in America. Developed economies have seen strong sell-offs in their domestic funding markets. Emerging markets have seen domestic rates rise even more. The effect has been less pronounced among euro zone members, who have seen their borrowing costs increase by 0.1 per cent to 0.35 per cent since the beginning of the year.

New Zealand is a prime example. Mostly coronavirus-free, its economy has run smoothly since the incumbent government was re-elected last October. It borrows in its own currency, and only about 10 per cent of its trade is with the United States. It has not passed a massive stimulus bill and inflation expectations have not changed materially. Yet, since January, its 10-year government borrowing costs have risen almost as much as the US Treasury’s, from 1 per cent to 1.7 per cent in March.

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Jacinda Ardern sweeps New Zealand elections, says voters endorsed her coronavirus response

This is not the first time we have been there. In the “Great Bond Massacre” of 1994, Alan Greenspan’s Federal Reserve surprised markets by raising short-term rates from 3 per cent to 3.25 per cent. Ten-year government bonds started selling off and the government’s cost of borrowing rose as a result, from 5.6 per cent at the end of January to 7.5 per cent in May and reaching a high of 8 per cent in November that year.

.css-1m2rp1p{color:#34b8b5;}The View | Coronavirus recovery: why non-US central banks must protect countries from rates cycle

The View | Coronavirus recovery: why non-US central banks must protect countries from rates cycle