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Federal Reserve Presses the Pause Button
// Global Economy Adapted to Interest Rate Increases
Yesterday Jean-Claude Trichet, the head of the European Central Bank (ECB), announced that the ECB had decided to leave the key interest rate at a level of 3% yearly. Meanwhile, two days earlier in the United States macroeconomic data were published, along with minutes from the last session of the Federal Reserve on August 8, at which it was decided to leave interest rates at 5.25%.
According to the published minutes, the members of the Federal Reserve committee that deals with operations on the open market called the inflation risks "dominating" and "significant," but they hope that the effect of raising interest rates will soon become evident and that inflation will slow. For example, for one of the published indicators of inflation, the index of personal consumption expenditures (PCE), growth in the second quarter was 4.1% in yearly calculations, in comparison with 2.0% in the first quarter. That is, interest rate hikes have not yet paid off. Meanwhile, the growth of the American GDP has already seriously slowed down. Precise data shows that the speed of growth in the second quarter (2.9%) turned out to be lower than that both the speed in the first quarter (5.6%) and the predicted speed (3.0%).
What will the Federal Reserve decide to do? On August 8, only one voice was heard in support of raising interest rates, while nine spoke against it. The risk of a possible recession is forcing the Fed to refrain from raising rates until the end of the year, despite the lingering high level of inflation. The market agrees. From the quotations for special futures on federal interest rates on the Chicago Stock Exchange, it is clear what investors' expectations are. After the publication of the statistical data and the minutes of the meeting, 92% of traders on that marker were sure that the Fed had finished its series of interest rate hikes or had taken a protracted pause at least until January or so. However, before the publication of the Fed's meeting minutes, Richard Fisher, chief of the Federal Reserve Bank of Dallas, noted that "those at the Central Bank do not carry that burden of inflation. That is internal, a part of our DNK."
The Threat of Success
What will this mean for Russian banking? Russia, like other evolving markets with their high risks and high profits, has once again become more attractive to global investors than the American market. According to data from Emerging Portfolio Fund Research (EPFR), a six-week period of outflow of funds from our market ended in the middle of June. Since then, there has been an influx to the tune of $20-70 million a week. In large part thanks to this, the Russian stock market closely approached $1 trillion in capitalization in August. By Bloomberg's calculations, it has emerged as number one in terms of capitalization among developing markets, overtaking South Korea.
The inflow of money is not as hefty as it was in February and March, when it reached $100-160 million a week, but all the same it is sufficiently large to cause analysts unease. Alfa Bank is calling on investors not to given in to "blind optimism" with regard to Russian stocks and to remember that the Russian stock exchange index is close to the "equitable" level at 1750 points. Vladimir Kravchuk, an analyst at Alfa Bank, adds that, from a technical point of view, the market is in a state of unstable equilibrium. A correction to a level of 1330 points is possible.
An analogous tendency is being noticed in the analytical laboratory "Vedi." The profitability of PIFs that invest in stocks reliably lags behind the dynamics of the market. This means that the control PIF, anticipating the resale value of the market and its overly fast speculative take-off, transitioned to more passive (defensive) strategies. It is, of course, not possible to rule out that the activity of the controls declined on account of the summer holidays. However, for practically all of August the lag remained at the same level that prompted a correction in May.
It is also worthwhile to consider that although the pause, announced by Federal Reserve Chairman Ben Bernanke, will facilitate the growth of the Russian market, it was made because of the slowing of the American economy. A slowdown could lead to a decline in demand for raw materials, which, in turn, will affect the price of shares in Russian raw-materials companies.
"Signs indicate that the long-expected slowdown of the American economy has finally arrived, leading to an influx of funds into bonds," believes the EPFR. What is more, money that is leaving the slowing American economy is now flowing to Japan. Among the stock markets of developed countries, Japan turned out to be the only one that experienced an inflow of funds for the week of August 17-23. This is unsurprising: the Japanese economy is giving off hopeful signals. Consumer inflation in July was only 0.2% instead of the expected 0.5%. Unemployment fell for the fifteenth month in a row, while GDP rose for a sixth successive quarter.
Reserve Engine
However, not everyone shares the belief that the Fed will not continue to raise interest rates for fear of a sharp economic downturn. Steven Jen, an analyst at Morgan Stanley, believes that interest rates may still be increased without the risk of a global recession. Jen calculated the global interest rate – the average rate from the central banks of the countries of the G10, adjusted for the size of the economy of each of the "big ten" countries. It turned out that the global interest rate for this July was 1.84%. This is a lot in comparison with the 0.07% in June 2004, but pales beside 2.28%, the average marker for the 1990s. Jen concludes that monetary policy is not yet sufficiently rigid to slow down the global economy. And the Fed's pause in interest rate hikes is only temporary. He thus expects that, towards the end of the year, the global rate will grow still more, to 2.2%, without leading to s sharp economic downturn.
One of the widely-held points of view on the matter is that the slowdown of the American economy will be partly compensated for by a quickening in other areas. According to experts from the Economist Intelligence Unit (EIU), the world is still at the very beginning of an economic recession. Analysts from the EIU lowered their forecasts for the speed of the growth of the global economy for next year from 4.8% to 4.7%. The main reason for such a cooling-off is expected to be a recession in America (a growth rate in 2007 of 2.2% instead of the expected 2.4%). However, the euro zone (growth rate 2.3%), Japan (2.2%), and especially China, which will become the main engine of growth, will help to compensate for the decline. In fact, the Chinese economy cannot be stopped. Forecasts for its growth have now climbed to 10.7% instead of the expected 9.5%, despite rising interest rates and oil prices. The most recent report from the World Bank explains the "Chinese anomaly" as being growth that is less due to foreign trade and more to domestic investment.
As such, it is entirely possible that already today much less of the fate of the worldwide economy depends on the Fed's rate hikes, though investors still wait with baited breath for each successive decision concerning interest rate changes.
M&K
All the Article in Russian as of Sep. 01, 2006
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