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Wednesday, June 22, 2022

Today's newsletter is by Brian Cheung, an anchor and reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

When the Fed made an abrupt pivot to more aggressively raise interest rates last week, it wasn’t just Fed watchers stateside that blinked.

The whole world did as well, triggering an international scramble to defend foreign exchange rates while addressing the larger problem of global inflation.

In the days following the Fed’s 0.75% rate hike, the Bank of England moved to raise interest rates, the Hungarian central bank unexpectedly raised its one-week deposit rate, and the Swiss National Bank raised rates for the first time since 2007.

In Australia, policymakers are eying the largest move the Reserve Bank of Australia has ever made in a single meeting. And jurisdictions with negative interest rates, where rate hikes were once unthinkable, are now pondering if they, too, need to move.

The European Central Bank said it will move in July to hike rates, and speculation is building that the Bank of Japan — considered to be the most rate-hike-averse major central bank — may soon be forced into a hike as well.

“This process – and the global spillovers it implies from US monetary policy – could drive over-tightening and a global recession,” Evercore ISI analysts warned last week.

Supply chain snags related to the COVID-related shutdowns in China and the war in Ukraine have similarly led to high inflation around the world. But much like the American conversation around rate hikes, the concern is that higher borrowing costs will also handicap growth prospects worldwide.

The problem for foreign central banks? They may not have a choice.

'Reverse currency war'

At the heart of the race to raise rates: defending the relative strength of domestic currencies, or what FX analysts are calling a "reverse currency war."

In a typical "currency war," central banks intervene to depreciate their domestic currencies to boost exports or encourage more direct investment from abroad.

The dynamic today is very different, with high inflation prompting central bank tightening. But a strong U.S. dollar is rocking foreign exchange markets, adding another layer of volatility to policymakers abroad.

Even the Bank of Japan is being tested on what it prioritizes more: FX stability or its dovish rate policy. The Japanese yen has fallen 16% year-to-date to as high as 136 against the U.S. dollar, a 24-year low.