Guest Post by Ned Davis Research
One of the biggest macro stories of this year
has been the persistence of inflation, which
was initially caused by COVID-related factors,
and was later intensified by the Russia/
Ukraine war. As a result, central banks are
now having to respond to these pressures at
the most aggressive pace since before the
Global Financial Crisis. Most of our indicators
suggest that this will lead to slower global
growth and present headwinds to equities.
Nonetheless, this quick tightening is coming
on the back of extreme accommodation,
which suggests that the economic damage
may not be as pronounced, reducing the
chances of a severe global recession.
Broad-based tightening
The breadth of global central bank tightening
is reaching its highest in nearly 15 years. The share of central banks whose last rate change was decrease has dropped from nearly 100% in early 2021 to 32%, the lowest since 2008.
Among the central banks that have not hiked rates yet, most have not loosened policy in quite some time. The exceptions are China, which has resumed an easing cycle to lift its slowing economy, and Russia, which cut its main policy rate in April, only partially reversing hikes to protect the ruble after its war with Ukraine erupted.
Contrary to past cycles, emerging market central banks were more aggressive than their developed counterparts early on, with some emerging markets beginning to raise rates as early as Q1 2021. Developed economy central banks lagged, as many viewed the 2021 spike in inflation as transitory. Today, however, the burden is similar, as around 70% of emerging and developed economy central banks are now in tightening mode.
Historically, global equities have not taken too kindly to the broad-based tightening in
monetary policy. As also shown in the chart, when fewer than half of the world’s central banks have been in easing cycles, global equities have tended to decline.
Consistent with slower growth
Not surprisingly, the tighter policy also argues for slower growth. As shown in the chart below, our measure of central bank breadth indicates that the global composite PMI will continue to ease over the next year.
The last times we saw such broad-based global rate-hike cycles were in 2008 and 2000. Recall that in those two cases, the global economy eventually fell into a severe global recession. However, that demise is not guaranteed as we also saw a global tightening cycle of this magnitude in 1995 that did not result in a severe global recession.
It’s happening fast
Global central bank tightening has been picking up at the fastest speed in over 15 years. Our GDP-weighted global central bank rate has climbed over 70 bp from a year earlier, the largest gain since 2006.
When the global central bank rate has risen above its three-year average, as it has been since the beginning of this year, equity market performance has been weaker.
Don’t forget about QT
Central banks that engaged in quantitative easing will also begin winding down their balance sheets. Shows the weekly change of aggregate government security holdings by major central banks. Since this measure is volatile, we also show a 26-week smoothing. As you can see in the performance box at the bottom of the chart, when this indicator has fallen, the MSCI ACWI has generally declined.
Keep in mind that some of the latest readings have been somewhat distorted by the strong U.S. dollar, as the data is converted to dollars to create the aggregate. Nonetheless, the Fed has already announced that it will start reducing the size of its balance sheet in June. In the
prior Fed tapering and subsequent quantitative tightening cycle that began in 2014, the Fed’s relative hawkishness was offset by growing balance sheets in the European Central Bank and Bank of Japan, and for a brief period, even the Bank of England. We likely won’t be seeing as much of that this time around.
An important point to make is that asset purchase programs are still fairly new, which means our analysis does not encompass many cycles. As a result, we take this analysis with some grain of salt.
Coming from extreme accommodation
It’s important to note that all this tightening is still coming from low levels. Although the aggregate central bank balance sheet will be shrinking, it will take several years for it to
get back to pre-COVID levels. The same goes for the global central bank rate. The current rate is still consistent with strong global growth. We estimate that the global rate will rise to around 2.60% by yearend, a level still associated with continued global expansion, and nowhere near levels observed before the Global Financial Crisis.
The cost of borrowing will remain quite low as the global real rate is still at a record
low, while the share of central banks with negative real rates is hovering around a record high.
Real rates are likely to get less negative (or turn positive) if and when inflation cools and
nominal rates rise. Even so, there is still a significant amount of room until the real rate
reaches Global Financial Crisis levels.
Economy slowing from unprecedented levels
In April, we downgraded our 2022 global growth forecast from 4.3% to 3.4%. The reduction reflected the tighter global monetary policy, as well as the rising risks brought by the Russia/Ukraine war and persistent supply chain issues.
Despite the large downgrade, growth is still in line with the long-term average. This
reflects a slowdown, albeit sharp, from an unprecedented 6.1% in 2021. This is faster than in the years preceding past large tightening cycles, especially in the advanced world.
As shown in the chart below, the unemployment rate is also starting from much lower levels, giving the global economy more wiggle room as policy tightens quickly.
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