Central banks are distancing themselves from the Fed

This article appeared originally in Gulf News: link to original article

The global financial grounds continue to shift, and as they do, actions taken by various central banks in different countries affect the attractiveness of each country and its economic sectors.

In a recent, and very cautious, move, the US Federal Reserve (Fed) pulled the brakes on its interest rate hikes. When the Fed takes such a decision, other central banks begin to weigh their options on whether to follow in the Fed’s steps or to chart their own monetary policy, subject of course to whether or not the currency is pegged to the dollar.

In a previous article published in this newspaper under the title “The end of Quantitative Easing”, I discussed the Fed’s decision to start tampering down its “quantitative easing” (QE) programme and to start increasing interest rates. I also made reference to how this move affected other central banks’ decisions to either follow suit or to continue their monetary policy regardless of what the Fed is doing, including the Bank of Japan (BoJ) and European Central Bank (ECB). This time is different.

The Fed decided that it is no longer reasonable to continue with rate hikes in 2019, contrary to its belief almost two years ago when it decided the time was ripe to initiate them.

For the Fed, the decision was taken to not tighten up liquidity too much for an economy that is still recovering from the aftermath of the 2007-08 financial crisis. Around the same time as the Fed’s announcement, the Bank of England (BoE) decided to hold its interest rates steady, while the Reserve Bank of India (RBI) decided to cut the lending rate in the world’s sixth largest economy.

The former is one that has had historic ties with its American counterpart, and the move came at a time when the UK is in dire need to protect and promote its attractiveness to foreign investors.

The decision by the BoE and the RBI comes at uncertain times, where they would rather loosen up their liquidity so that the economy does not run out of steam. What those two decisions also highlight, with the RBI having plenty of room to manoeuvre rates unlike the BoE, is this move away from a US dollar-centric financial system and the Fed as its guardian.

Today, monetary decisions by central banks around the globe emphasise the shift away from the Fed’s policy, with the decisions being shaped by their domestic political and economic landscapes rather than the Fed’s actions.

When analysed from a global perspective, taking into account the increasing number of currency swap agreements between central banks, — agreements to directly exchange one’s currency with another without having to go through a third currency like the US dollar — the world’s monetary future is being driven away from its overreliance on the dollar, even if that takes decades to fully materialise.

Moreover, the E3 countries — Germany, France, and the UK — recently established a special purpose vehicle (SPV), officially called Instex (Instrument in Support of Trade Exchanges), to commence and facilitate direct payments between the EU and Iran that bypasses the dollar and having to trade and settle payments in it.

Taking all of the above into account, it’s safe to assume that there’s a global shift from what was put into place by the Bretton Woods System, and away from the central role played by the dollar and the Fed.

Such a shift though could take years, if not decades, before it results in a new global financial order of direct central bank-to-central bank relations, a mixed and possibly more balanced distribution of forex in trade and financial transactions, as well as higher mobility in how investments move from one country to another.

We are looking at three very possible outcomes. The first outcome is that central banks will continue moving away from the practicality of moving in sync with the Fed, whether in direction or in magnitude. Decisions taken by central banks will put domestic factors before global ones, and interest rate moves would be more drastic and extreme compared to today’s milder ones.

Secondly, there will be further reduction in the number of currencies pegged to the dollar. The third possible outcome is the future ineffectiveness of US’ imposed sanctions, already evident from currency swap agreements and Instex.

The last thought that I want to leave you with: What countries will be able to sanction other countries in the future?