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Desmond Lachman writes that conditions in the US were already sufficient to justify a halt to the Fed’s rate hike.
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About the author: Desmond Lachman He is a senior fellow at the American Enterprise Institute. He was Deputy Director of the Policy Development and Review Department at the International Monetary Fund and Chief Economist in Emerging Markets at Salomon Smith Barney.
There is an apocryphal story about the investigation into the sinking of the Titanic. When the captain of the Titanic was asked why he did not swerve to avoid the iceberg, he replied, “Which iceberg?”
judging by Federal Reserve Chairman Jerome Powell’s silence on the warning signs of crises in the world’s three largest sovereign bond markets, one has to wonder if something similar could soon be said of him when investigating a future crisis in the financial markets. When asked why the Fed has not shifted from its aggressive monetary policy stance of raising interest rates and quantitative tightening in the face of looming sovereign debt crises, it might answer, “Which debt crises?”
The fact of the matter is that for various reasons we may see debt crises as early as this summer in the three largest sovereign bond markets in the world: the United States, Japan and Italy. Should any of these crises occur, they could destabilize the currently illiquid global financial markets. They could do it in the same way that the recent collapse of the UK gold market following former Prime Minister Liz Truss’ ill-advised budget rocked the UK’s financial markets.
By far the most disturbing of potentials debt crises It is in the United States. This is not just because the United States has by far the largest market for government debt. This is also because the US debt market acts as the risk-free rate by which other interest rates around the world are set. A rise in the price of the 10-year US Treasury note may reverberate around the United States International Economy.
The reason for the fear of the US sovereign debt crisis this summer continues confrontation to raise the debt ceiling. In a letter to House Speaker Kevin McCarthy, Treasury Secretary Janet Yellen indicated that the US government reached its debt ceiling on Thursday. She also noted that the Treasury is now taking “extraordinary measures” that would allow the government to avoid a debt default at least until early June.
The large gap between the Republican House majority and the Biden administration’s opening positions on the issue is likely to increase the likelihood of facing a protracted debt ceiling. McCarthy, beholden to the GOP’s Freedom Caucus, continues to stress that he will not agree to raise the debt ceiling without committing to deep cuts in public spending, including spending on Social Security and Medicare. For his part, Biden believes the debt ceiling should be raised without any strings attached because Congress has already approved essential spending.
As we should have learned from the 2011 US debt ceiling battle, financial markets can become highly unstable if debt negotiations fall to the wire. This was the case in 2011 although a debt default was finally avoided. Needless to add, if the US actually defaults, all hell will break loose in the global financial markets as the creditworthiness of the world’s largest government debtor is called into question.
The reason for the fear of the Japanese sovereign debt crisis is the recent rise in the core inflation rate in that country to 4%. new head for Bank of Japan He is likely to take office in April. A crisis could come soon after. Inflation may force the Bank of Japan to abandon its current policy of yield curve control. This, in turn, could lead to a sharp rise in long-term Japanese government bond yields. As happened recently in the United Kingdom, an unexpected rise in government bond yields could lead to the infiltration of major Japanese financial institutions.
As if this weren’t enough to keep central bankers up at night, there is also a very real risk of another round of European sovereign debt crisis unfolding later this year. It will be concentrated in Italy, which has the third largest sovereign bond market in the world.
So far, the European Central Bank has kept the heavily indebted Italian government afloat by purchasing that country’s total net government bond issuance under its policy of quantitative easing. However, the European Central Bank announced that starting in March it will begin its quantitative tightening policy at a pace of €15 billion ($16 billion) per month. That should raise the question of who will finance the Italian government’s total borrowing needs of more than $250 billion this year and at what interest rate?
Even before the sovereign-debt crisis, rapidly declining US inflation and a slowing US economy could have justified a pause in Fed rate hikes and a lessening of the pace of quantitative tightening. Now that there is good reason to fear a sovereign debt crisis soon in at least one of the major debtor nations, there seems to be even more reason why. feed it To pause if to avoid exaggerating monetary policy.
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