The primary cause of the market chaos is the Federal Reserve’s fight with inflation. Because the Fed has lost the first three or four rounds since prices began to surge in 2021, it is now swinging harder. The central bank expects to raise the federal funds rate to nearly 4.5% by the end of the year and higher still in 2023. The outlook for rates is rippling through America’s financial system. The cost of 30-year mortgages is nearly 7%. Junk-bond yields are already over 9%, which has caused the issuance of new debt to dry up. Bankers who underwrote leveraged buy-outs when yields were lower are suddenly finding themselves hundreds of millions of dollars in the red. Pension funds which gorged on opaque private assets in pursuit of higher returns when rates were lower must now tot up their losses as risky investments slump in value.
Yet it is outside America where the financial effects of the Fed’s monetary tightening have been most severe. The surging dollar is painful for energy importers that were already grappling with higher costs. China has responded by making it harder to short the yuan, which in the offshore market hit a record low against the greenback on September 28th. India, Thailand and Singapore have intervened in financial markets to support their currencies. Excluding China, emerging-market currency reserves have fallen by over $200bn in the past year, according to JPMorgan Chase, a bank—the fastest fall in two decades.
Advanced economies can usually withstand dollar strength. Today, if anything, they are showing greater signs of immediate stress. Some of the worst-performing currencies in 2022 are from the rich world. Sweden raised rates by a full percentage point on September 20th and still saw its currency fall against the dollar. In Britain surging yields on government debt have failed to attract much foreign capital. The Bank of Korea is lending currency reserves to the national pension fund so that it buys fewer dollars in the open market. In Japan the government has intervened to buy yen for the first time this century, despite the apparently ironclad determination of the central bank to keep interest rates low.
Part of the explanation for the pressure on advanced-economy currencies is that many central banks have hitherto failed to keep pace with the Fed’s tightening—but with good reason, because their economies are weaker. The energy crisis is about to plunge Europe into recession. South Korea and Japan are suffering the knock-on effects of an economic slowdown in China, brought about by its housing crisis and zero-covid policy.
