The International Monetary Fund’s annual meeting and the World Bank’s annual meeting this week may not have an immediate crisis before them, but their top priority is no less important.
In October, there were some market aftershocks resulting from Liz Truss’s mini-budget crises. In March, there was concern about a global financial crisis and a systemic one after a number of American banks collapsed. The annual meetings in Marrakesh begin today, and the market is once again jittery about central bank interest rate trends.
investors dumped government bond in the last two weeks. This caused the yields on US Treasury bonds with longer maturities to reach their highest levels since the financial crises.
Steen Jakobsen is the chief investment officer of Saxo Markets. He believes that the recent jump in bond yields presents a “danger moment” for investors and markets. We are clearly at a point where something is breaking. “Real [interest] rates have reached an unsustainable level and the global economy will soon collapse while central banks are asleep.”
These central bankers are not yet too concerned about bond markets that are in decline. However, they will keep an eye on the global yields which reflect their belief that rates will stay higher for a longer period of time.
Mary Daly of the San Francisco Federal Reserve said that a jump in yields was equivalent to an increase in interest rates, which makes it more likely the US Fed will not need to tighten its monetary policy this year.
Investors have mixed opinions about the increase in yields. Some investors see this as a “normalization” of the bond markets after more than 10 years of ultra-low rates and negative real interest rates (which remove inflation). Some believe the bond sell-off is a reflection of a greater fear of the market’s capacity to absorb large amounts of debt incurred by profligate governments who are turning up the spending taps, and central banks who are reversing decades of quantitative easing.
Steen stated that the market does not believe any government would be willing to return to a conservative fiscal policy. Unfortunately, this is true. “Populism, and delivering the green transformation, is not only expensive, but it’s also a tax on consumers and businesses in its current form.”
It is difficult to assess bond market dynamics because 30-year assets have been hit the hardest, not shorter-term debt. This week, the US 30-year Treasury yield reached 5 percent for the first since 2007. It has also been the hardest-hit quarter in bond sales since 2009.
Last year at this time, investors were dumping the British equivalent of 30-year gilts after the mini budget nearly threatened pension funds who had adopted liability-driven strategies. The mini-budget experiment , which left a £45 billion hole in public finances, was the cause of the panic.
The Fed is unlikely to cut interest rates next year because some bondholders have sold longer-dated bonds this time around, as the American economy has performed better than expected. In fact, by increasing borrowing costs and tightening the financial conditions, it is more likely that the US economy will slip into recession.
Albert Edwards, strategist at Societe Generale said that he “never experienced such uncertainty regarding where we are within the economic cycle.” Are we still in the midst of the long-promised economic recession, or have we just begun a new cycle? Investors are increasingly convinced that the second scenario is more likely. “My own view is that there’s still a recession, but like many others, I have held this view for a long time and have been proven wrong so far.”
The IMF urges central banks to remain steadfast despite the risks of financial disasters caused by sharply increasing yields. Kristalina Georgeieva, the managing director of IMF said that to win the battle against inflation interest rates must remain higher longer. It is important to avoid premature policy easing, as this could lead to a resurgence of inflation. High inflation undermines investor and consumer confidence, damages the basis for growth, and most importantly, harms the poorest members of society.
This week, the IMF is expected to confirm the investors’ outlook for the United States by upgrading its 2024 growth forecast. Most of the other projections remain unchanged. Georgieva stated that the projections suggest the world GDP will be below the average of 3,8% in the 20 years before the pandemic.
A rising cost of borrowing is bad news not just for the governments and banks who have accumulated debt. The IMF also has to charge more for its funding of countries that need aid. Special drawing rights are the fund’s de facto reserve currency. The SDR reserve lends to countries based on an interest rate that is calculated based upon the average of the currencies included in the SDR basket, which includes the dollar, pound, euro, yen, and yuan.
Sander Tordoir from the Centre for European Reform calculates that the IMF can charge rates as high as 8% for lending to debtor nations. This “discourages countries from approaching the IMF.” The burden of high interest rates paid to the IMF can worsen budgetary problems rather than help them. Sander Tordoir, from the Centre for European Reform, calculates that the IMF’s lending to debtor countries could be charged at rates as high as 8 per cent.