Don’t Look Now: Britain is Not the Only Nation Facing Economic Turmoil

Anyone living in Britain could be forgiven for assuming that the only real and important economic crisis is the one facing the UK in the form of a hard Brexit. It is certainly true that this country is close to committing an historic act of economic self-harm.

But other countries are facing stiff headwinds — and it is only British exceptionalism that makes the media and commentariat focus so totally on it.

For many smaller countries the real threat they face stems from the steady increase in US Federal Reserve interest rates that look pretty baked in over the coming months.

The semi-annual monetary policy report that the Fed released this month indicated that policymakers remained bullish on the economy’s prospects and that what it called “gradual” interest rate hikes would continue.

The world’s most influential central bank last raised interest rates in March when it hiked borrowing costs by 25 basis points (a quarter of one percentage point) to a target band of 1.5-1.75 per cent. The official cost of borrowing in the US has already climbed by 1.5 percentage points since the end of 2016.

According to ING, the Dutch bank, with inflation set to pick up over the summer, three more quarter-point rate increases in 2018 are pretty much given. Were momentum to remain strong into 2019, there is a chance that we could see another three hikes in 2019.

In other words, the Fed could tighten monetary policy by another 1.5 percentage points to 3.0-3.25 per cent. This will make borrowing more expensive globally as money markets react to the US, and especially so for economies that have tied their monetary policy to the dollar.

This could be the progenitor of financial crises across the world. One bank, Standard Chartered, has constructed an index based on 33 crises across 68 countries over a period of 33 years and provides a consistent framework that it says may give early warnings about emerging crises.

It calls it the Icarus index, presumably a coy nod to the Greek myth of the son of the eponymous inventor of a set of feathers and wax that enabled flying, but who flew too close to the sun and lost his life when the wax melted.

Icarus suggests that key variables to track include the US interest rate and a technical measure known as the “slope” of the graph of the difference in the yields of the two-year and 10-year US Treasury bonds. The latter had flattened to just 0.25% last week (it was 2.6% in December 2013).

Bond experts say that when it inverts, meaning the yield on two-year bonds is higher than for 10-years — despite “longer” money usually commanding a premium — it is a reliable indicator of an impending economic slump.

the key risk over the next six months is that monetary conditions tighten more rapidly than expected

Standard Chartered says that its measures are the best proxies for the state global liquidity and risk appetite. The latest running of its index shows that external vulnerability has risen overall since its last update in December 2017.

Argentina and Pakistan joined Jordan in the high vulnerability zone. It gives the odds of a crisis in Jordan at almost 40%, and almost 30% for Argentina.

In addition, Greece, Brazil, Egypt, Turkey, Ukraine, Portugal and Indonesia also sit in what it calls the moderate risk category with a chance of 2 per cent to 9 per cent. Ironically Britain joins the US at close to zero risk.

For Standard Chartered the key risk over the next six months is that monetary conditions tighten more rapidly than expected. The Bank of England may raise its main interest rate as soon as next month and the European Central Bank said in June that it would end its asset purchase programme in December, tapering monthly purchases from €30bn to €15bn from October until December. UBS bank is of many that expects this process will push up eurozone bond yields.

Trade tensions also could result in a reduced appetite among investors for assets such as emerging market government bonds, which force governments to raise the interest rates they pay to attract buyers.

There is a chance that the Fed may not press ahead with rate rises at the pace some predict, so bringing relief to vulnerable countries with large deficits and so high debt servicing costs.

The first is renewed market turmoil: while the Fed appears fairly sanguine about a sharp spike in a measure of financial market volatility seen in early February, a more severe and sustained bout of volatility that leads to a tightening of financial conditions could give the Fed reason to pause.

The second is such an escalation of tensions around the US’ aggressive tariff policy into a full-blown trade war, which could cause the global economy to slow down prematurely.

So as British MPs and Brussels negotiators enter the holiday season thinking that at least they have a few weeks off before the negotiations stutter into life again, they should remember there are other risks out there that may bring an early dose of summer rain.

More about the author

About the author

Phil has run Clarity Economics, a London-based consultancy, since 2007 and, before that, was Economics Correspondent at The Independent.

Phil won feature writer of the year Work Foundation Work World media awards in 2009, and was commended by the Royal Statistical Society in 2007.

He is the author of Brilliant Economics and The Great Economists.

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