August for central bankers is Jackson Hole month, when the Kansas Federal Reserve Bank has invited leading central bankers, finance ministers, academic professionals and financial market participants since 1974 to discuss current international trends and central bank policy issues in Jackson Hole, Wyoming. The Policy Symposium is traditionally opened by the Chairman of the Federal Reserve Board. Last year’s theme, “Structural Shifts in the Global Economy” fundamentally reviewed the lingering impact of the pandemic, inflation and monetary policy response. Chairman Powell re-iterated last year that “two per cent is and will remain our inflation target.”

This year’s theme is “Reassessing the Effectiveness and Transmission of Monetary Policy,” at a time when the US economy is surprising everyone on the upside, whereas other major economies, Europe, UK, Japan and China are all facing considerable risks on the downside. On 21 August, the Fed released the minutes of the last Federal Open Market Committee (FOMC) meeting held on July 30/31 when it left interest rates unchanged at 5.25 to 5.5 per cent per year. “The staff’s outlook for growth in the second half of 2024 had been marked down largely in response to weaker-than-expected labour market indicators… The vast majority observed that, if the data continued to come in about as expected, it would likely be appropriate to ease policy at the next meeting.”

Thus, the market expects that the current FMOC will cut interest rates in August or September, with one further cut later in the year. US stock market investors are basically waiting for these rate cuts to guide higher stock prices. On July 31, the Bank of Japan announced an interest rate increase to around 0.25 per cent per annum from the previous range of 0.0 to 0.1 per cent. This was remarkably the second increase in 17 years over which Japanese monetary policy sought to fight deflation and slow growth. In the Summary of Opinions of the Monetary Policy Meeting released on 8 August, the Bank of Japan noted that “Real interest rates are at their most negative levels in the past 25 years, and the degree of monetary accommodation, based on various indicators, has been significantly above its average during the period of quantitative and qualitative monetary easing (QQE).”

Hence, the Bank of Japan decided to lift interest rates to reduce the high negative real interest rate drag on the domestic economy. As a result, the Yen appreciated from the peak of 161 to the dollar on July 11, when the Japanese Ministry of Finance reputedly intervened, to fall to 142 on 5 August, as the Japanese Yen carry trade unwound. In the past 17 years, with Yen interest rates at near zero, it has been profitable to borrow yen and invest in higher interest rate currencies like the dollar to earn a “carry” interest differential, made more profitable by the declining yen exchange rate. The low Yen interest rate has supported the real economy in terms of exports, but has forced Japanese savers to invest mostly in dollars and euros to earn higher income.

Japan has therefore been a major supporter of global liquidity, with the highest net international investment position of $3.2 trillion at the end of March 2024. Japan is the largest holder with over $1.17 trillion worth of US Treasuries with China next at $770 billion. Normalization of Japanese interest rates together with lowering of US interest rates would therefore reduce the attractiveness of US bond holdings, as Japanese investors return to Yen bonds to protect against exchange rate risks. The narrowing of interest rates between the dollar and Yen/Euro interest rates will lessen the strengthening pressure on the dollar. As the Bank for International Settlements has persistently warned, high US interest rates have been contractionary on the global economy, since the emerging market and developing economies (EMDEs) have an outsized debt denominated in US dollars.

Thus, prospects of US interest rate cuts are signs that the global economy will also reflate. The Malaysian ringgit, which was weak due to interest differential with the dollar, has been the best performing currency in the Asian region, appreciating to 4.37 on August 22, from a peak of 4.79 on 18 April. Fundamentally, contrary to earlier market expectations that the world economy may be heading towards recession in the medium term, due to various structural weaknesses, trade protectionism, global warming and geopolitical tensions, the world is muddling through as real interest rates decline. Since the Fed is in charge of US monetary policy, but indirectly responsible for global monetary conditions due to the “exorbitant privileged” position of the US dollar as the major medium of exchange and store of value, the Fed’s cutting of interest rates will help reflate global liquidity.

At the same time, Japan’s return to “normal” monetary policy from excessive “quantitative and qualitative easing”, will reduce the under-valuation of the Yen and in effect, help depreciate the dollar, which is tending towards excessive strength. Europe, on the other, is slowly waking up to the reality that continuous war in Ukraine may not be to its best advantage. Europe has to revive its own trade competitiveness in the face of huge competitive threat from Chinese EVs and manufacturing prowess. The Chinese economy is addressing its structural drags from the weak property market, as well as aging population. All in all, those who see the world as a glass half full, like myself, see better days ahead for emerging markets, because lower US dollar interest rates will mean a reversal of flows back to emerging markets. Asean is poised for economic stimulus, because the incoming political leaders in Indonesia and Thailand all want to push economic growth.

Indonesia Presidentelect Prabowo has declared 8 per cent GDP growth as part of his wish-list, whereas returning Thai politician Thaksin will clearly desire economic revival as part of his ambitions. Those who see the glass half empty will continue to worry about the prospects of war in the Middle East, Ukraine or the South China Sea. That is what is keeping gold prices high. They also worry about the return of President Trump. The coming days will be a roller coaster ride. Predicting the future is hard business.

(The writer, a former Central banker, comments on global affairs from an Asian perspective.)