How Fed Rate Cuts Affect The Global Economy

Summary

The Federal Reserve, as the world's largest central bank, significantly influences the global economy. Its decisions on interest rates, which rose to over 5% from 2022 to 2023 to combat inflation, affect currency values and economic growth worldwide. The US dollar's status as the world's reserve currency is underpinned by trust and economic strength. As economic indicators suggest a slowdown, the Fed considers rate reductions, which can disrupt stock market strategies like the carry trade and impact emerging markets. Additionally, the Fed's use of swap lines during crises provides financial stability globally, though countries like China are exploring alternatives to the dollar.

Takeaways

• 🏛️ The Federal Reserve is recognized as the world's most influential central bank, significantly impacting the global economy.
• 🚂 The US economy, steered by the Fed, is the largest globally and a key driver of the Fed's importance.
• 📈 From 2022 to 2023, the Fed's controlled interest rates rose above 5% to combat inflation, influencing many central banks to follow suit.
• 💵 Higher interest rates can strengthen the value of the dollar, making it more attractive relative to other currencies.
• 📉 The Fed's monetary policy adjustments can disrupt stock market strategies, such as the carry trade, which involves borrowing in cheaper currencies to invest in higher-yielding ones.
• 🌐 The Fed's decisions have a ripple effect on the global economy, with actions not limited to the US but affecting other regions as well.
• 💼 The economic slowdown signs in the US labor market by summer 2024 led the Fed to consider reducing interest rates.
• 🌐 The use of US dollars is widespread in global foreign reserves and forex trades, giving the Fed additional influence.
• 🔄 Swap lines, temporary loans between central banks, are a tool used by the Fed to stabilize global dollar funding markets during crises.
• 📊 While countries like China attempt to internationalize their currencies and reduce reliance on the dollar, the US dollar remains dominant with no clear successor.

Q & A

Why is the Federal Reserve considered the world's largest central bank?

The Federal Reserve is considered the world's largest central bank due to the size and influence of the US economy, which is guided by the Fed. The US economy's stature is one of the key drivers of the importance of the Fed.

How does the US economy's performance affect the global economy?

The US economy, being one of the largest and fastest-growing, acts as a locomotive for the global economy. Other central bankers often have to implicitly follow the Fed's policies, even if they claim not to.

What is the significance of the Federal Reserve's policy adjustments?

The Fed's policy adjustments can alter the value of the dollar both in the United States and globally, impacting economic conditions and financial markets worldwide.

Why is the US dollar considered the world's reserve currency?

The US dollar is seen as the world's reserve currency due to a huge trust factor in the US economy and its financial stability, which has been managed over a long period to support a strong dollar.

How did the Federal Reserve's interest rate changes between 2022 and 2023 impact the global economy?

From 2022 to 2023, the Fed's interest rates rose to over 5%, leading many central banks to do the same, making loans more expensive and slowing economic development to combat inflation.

What is the relationship between interest rates and the value of a currency?

Higher interest rates can increase the value of cash. If interest rates are high relative to other countries, the dollar appreciates.

How do changes in the Fed's interest rates affect wage growth and inflation?

Higher interest rates make it more difficult to receive raises at work, which can help prevent wage-price spirals that escalate inflation.

What economic indicators prompted the Federal Reserve to consider reductions in interest rates by the end of summer 2024?

Signs of an economic slowdown in the US labor market, including positive job growth but a slight increase in the unemployment rate, prompted central bankers to consider rate reductions.

How can changes to the Fed's interest rate disrupt stock market trading techniques?

Changes can disrupt techniques like the carry trade, where investors borrow in cheaper currencies to invest in higher-yielding ones. If the Fed cuts rates more than expected, it can depreciate the dollar and affect these trades.

What is the role of swap lines in the Federal Reserve's international financial policy?

Swap lines are temporary loans from one central bank to another, used to ensure disruptions abroad don't create problems domestically. They can halt rapid swings in currency values and restore normal activity in dollar funding markets.

How does the Federal Reserve's mandate affect its decisions on interest rates?

The Fed's mandate is US-based, meaning it will do what makes sense for the US economy, but its decisions also have spillover effects on the global economy.

What efforts are being made to internationalize the Chinese yuan, and how successful have they been?

China has extended swap lines to about 40 central banks and is moving towards central bank digital currencies. However, the yuan still accounts for a small percentage of global payments and is far behind the dollar and euro.

Outlines

00:00

🌎 Global Economic Influence of the Federal Reserve

The Federal Reserve, as the world's largest central bank, plays a pivotal role in the global economy. Its decisions significantly affect the US economy, which acts as a locomotive for global economic growth. Other central banks often follow the Fed's lead, even if they claim otherwise. The Fed's policy adjustments, such as interest rate changes, can alter the value of the US dollar both domestically and internationally. The US dollar is considered the world's reserve currency, largely due to trust in the US economy. The Fed's decisions are influenced by labor market conditions and inflation, and its actions can have far-reaching effects, including disrupting stock market trading techniques and affecting financial conditions worldwide. The script also discusses the impact of the Fed's policies on emerging markets and the use of swap lines during crises to stabilize dollar funding markets.

05:01

📉 Financial Conditions and the Role of Swap Lines

The script highlights the concerns of emerging markets regarding the tightening of financial conditions, particularly in the US. It discusses how non-recessionary rate cuts in the US can affect capital flows and benefit emerging market policymakers. The dollarization of some countries makes them more susceptible to the Fed's decisions. The script explains the concept of swap lines, which are temporary loans from one central bank to another, used to stabilize foreign exchange markets and prevent rapid currency value swings. The pandemic is cited as an example of the Fed's use of swap lines to restore normalcy to dollar funding markets. The script also touches on China's efforts to internationalize the renminbi and the movement towards central bank digital currencies, but concludes that the US dollar remains dominant with no clear alternative in the near term.

Keywords

💡Federal Reserve

The Federal Reserve, often referred to as 'the Fed,' is the central banking system of the United States. It plays a crucial role in the global economy by setting monetary policy, including interest rates, which can influence economic growth, employment, and inflation. In the video, it's highlighted as the world's largest central bank, affecting not just the U.S. but also global markets.

💡Global Economy

The global economy encompasses all economic activities and actions of all countries. The video script mentions that the U.S. acts as the 'locomotive' of the global economy, indicating that economic policies in the U.S., particularly those set by the Fed, have a ripple effect worldwide.

💡Interest Rates

Interest rates are the cost of borrowing money and are a key tool used by central banks like the Fed to manage economic activity. Higher rates can slow down the economy by making borrowing more expensive, while lower rates can stimulate spending and investment. The script discusses how the Fed's interest rate hikes to over 5% have had global implications.

💡Inflation

Inflation refers to the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. The script mentions that central banks worldwide have raised interest rates to combat inflation, indicating its importance in economic policy.

💡Carry Trade

A carry trade is an investment strategy where an investor borrows a currency with a low interest rate to invest in another with a higher interest rate. The video script explains how changes in the Fed's interest rates can affect this strategy, potentially leading to a depreciation of the dollar if the Fed cuts rates more than expected.

💡Currency Appreciation

Currency appreciation refers to an increase in the value of one currency relative to another. The script discusses how higher interest rates in the U.S. can lead to the appreciation of the dollar, making it stronger against other currencies.

💡Labor Market

The labor market consists of all individuals who are available for work, the employers, and the government. The video script indicates that the Fed monitors the U.S. labor market to adjust its policies, as changes in employment and wages can influence inflation and economic growth.

💡Economic Slowdown

An economic slowdown refers to a period of reduced economic growth. The script mentions signs of an economic slowdown in the U.S., which has prompted central bankers to consider reducing interest rates to stimulate the economy.

💡Swap Lines

Swap lines are temporary reciprocal currency arrangements between central banks. The video explains how the Fed uses swap lines to provide dollars to other countries, which can stabilize foreign exchange markets and prevent global financial disruptions.

💡Dollarization

Dollarization refers to a situation where the U.S. dollar is used as the primary currency in a country, either alongside or instead of the local currency. The script notes that some countries are dollarized, which means they are more sensitive to changes in U.S. monetary policy.

💡Central Bank Digital Currencies (CBDCs)

CBDCs are digital forms of central bank money, which could potentially offer an alternative to physical cash. The video script discusses the rise of CBDCs, such as the digital yuan, as potential challengers to the dollar's dominance in international transactions.

Highlights

The Federal Reserve is the world's largest central bank and plays a crucial role in the global economy.

The US economy is considered the locomotive of the global economy, influencing other central banks' policies.

The Fed's leaders anticipate a slowdown in the US job market, prompting policy adjustments.

The Fed's policy changes can affect the value of the dollar both in the US and globally.

The dollar is seen as the world's reserve currency due to a significant trust factor.

The US economy's size and growth are key drivers of the Fed's importance.

From 2022 to 2023, the Fed raised interest rates to over 5% to combat inflation.

Higher interest rates can lead to a stronger dollar and affect global economic development.

The Fed's management of interest rates is based on labor market and inflation observations.

By summer 2024, the Fed considered reducing interest rates due to economic slowdown signs.

Changes in the Fed's interest rate can disrupt stock market trading techniques.

The carry trade, a popular investment strategy, can be affected by the Fed's rate decisions.

The Fed's mandate is US-based, but its actions have global economic implications.

The Fed's rate cuts can affect financial conditions in many parts of the world.

The Fed's actions have a spillover effect on other economies, especially emerging markets.

The Fed uses swap lines to provide dollars to other countries during financial crises.

Swap lines can prevent rapid swings in currency values and stabilize global markets.

The use of US dollars is prevalent in global foreign reserves and forex trades.

China has been trying to internationalize the renminbi, but it still lags behind the dollar and euro.

Central bank digital currencies are emerging, but they are not expected to replace the dollar in the near term.

Transcripts

The Federal Reserve is the world's largest central

bank.

The fed is important to the global economy in so many

different ways. The US is the sort of the locomotive

of the global economy.

Even though other central bankers often say that they

don't follow the fed.

They often implicitly have to.

The Fed's leaders see a slowdown coming in the US job

market.

The time has come for policy to adjust.

The time has come for policy to adjust.

Since the quote that's been heard around the world.

Those changes can alter how much dollars are worth in

the United States and beyond.

There's a huge trust factor, and therefore the dollar

is seen as the world's reserve currency.

So how did the fed become the world's most powerful

central bank, and what do its upcoming decisions mean

for the global economy?

The US economy, guided by the fed, is the largest in

the world.

The US economy's stature is one of the key drivers of

the importance of the fed.

Given that the US economy remains one of the largest

economies in the world, and certainly of late, one of

the ones that's been fastest growing.

A country and its currency doesn't become important and

the world's most important currency overnight.

The value of the currency depends a lot on the

economy. If the economic conditions are right, there's

economic growth in the region.

Then the currency will also appreciate and do well.

From 2022 to 2023, interest rates controlled by the fed

rose to over 5%.

Many central banks around the world did the same,

making loans more expensive and slowing economic

development to halt a global bout of inflation.

Everybody took the elevator on the way up.

Tightened monetary policy very rapidly.

The fed was at 5.5%.

Most other central banks were either close to or

slightly lower to the Fed's policy rate.

Certainly, across advanced economies.

Higher interest rates can increase the value of cash.

If interest rates are high relative to other countries,

the dollar is appreciating.

Higher interest rates also make it more difficult to

receive raises at work.

This can prevent escalating bouts of inflation that

economists call wage price spirals.

The fed has managed the currency for a long period of

time in a way that is supportive of a strong dollar,

so they will tend to cut off any threat of wage price

spirals. And they've done that for a long period of

time.

The Federal Reserve manages those interest rates based

on what they see as happening in the labor markets and

inflation.

By the end of summer 2024, signs of an economic

slowdown appeared in the US, prompting central bankers

to consider reductions in interest rates.

As the fed lowers its rate, it's going to get closer to

other central banks interest rates.

Changes to the Fed's interest rate can disrupt stock

market trading techniques, too.

And that's really what we saw in early August, where we

had.

This.

Sudden global market sell off that initially started

off of a weaker than expected payroll report in the

US.

The cooling in labor market conditions is unmistakable.

We still have job growth that was positive.

We had a slight increase in the unemployment rate.

What happened was that it was weaker than expected.

The weak labor data led investors to abandon a popular

strategy called the carry trade.

Here's how it works.

You borrow in a currency that is that is cheaper,

undervalued, and then you invest in a higher yielding

currency.

For example, an investor might borrow money in Japanese

yen to buy US assets like the ten year Treasury bond.

When a carry trade is working well, that means the

value of my my dollar assets that I've just purchased

are appreciating compared with my my yen borrowing

that I've used to finance the trade.

But that strategy can backfire.

If the fed is is all of a sudden expected to cut more

than people were expecting?

That can start to depreciate the dollar.

So if one central bank cutting interest rates, the fed

and another central bank is raising interest rates.

The Bank of Japan. It leads to a weaker dollar and an

appreciation in the yen.

You have this spread delta between policy rates.

That is narrowing.

The unwinding of those technical positions can

actually exacerbate some of the movements in foreign

exchange currency.

So it's not just about sort of a small shift in

expectations, but that small shift in expectations can

be magnified into a really big move.

The Fed's mandate is a US based mandate.

So the fed is going to do whatever makes sense for the

US. But obviously the fed is also keeping the global

economy in mind.

The rate cuts also affect financial conditions in many

parts of the world.

Why is the fed followed so broadly internationally,

globally? Because the actions of the fed, Federal

Reserve Board, they're not just limited to the US,

they have a spillover effect in other parts of the

world. Also, there's some saying that when the US

sneezes, emerging markets catch a cold.

The tightening of financial conditions, particularly in

the US, has been one of the major concerns for

emerging markets. If we think we're on the precipice

of of non recessionary rate cuts in the US, some of

those capital flows can start to reverse and that can

be a boon for for emerging market policy makers.

And some countries are dollarized.

So those countries will feel an even bigger impact on.

The world's use of dollars gives the fed some

additional influence in times of crisis.

There are strong inter-linkages financial linkages, and

in today's very interconnected world, those types of

movements occur very rapidly.

The pandemic was a notable example.

The fed was sending money to other countries using

their so-called swap lines.

The introduction of the swap lines has really restored

dollar funding markets around the world to fairly

normal levels of activity.

Swap lines are temporary loans sent from one central

bank to another. For example, the Bank of Japan had

$225 billion in outstanding withdrawals from its swap

line with the Federal Reserve at a point in 2020.

The fed provides those loans to a select group of

international authorities to ensure that disruptions

abroad don't create problems back in the States.

It's a great tool during periods of financial crisis,

to know that the fed is there, willing to provide

dollars when the global economy needs it.

In a way, it's an insurance.

If the ECB needs dollars, what are their options?

They can go to a swap line, or they can sell the US

Treasury securities that they own.

You'd rather not have everybody selling their US

Treasury securities because they need dollars.

You'd rather have some other option available to them,

like a swap line.

The use of swap lines can halt rapid swings in the

value of dollars and other currencies.

If you look at global foreign reserves, if you look at

foreign exchange trades, all of those trades are done

mostly in US dollars.

And wherever there is another currency, its share is

relatively minimal.

When they were used in the pandemic, swap lines were

responsible for nearly 20% of the increase in the

Fed's balance sheet.

Other economic heavyweights like the European Central

Bank and people's Bank of China offer swap lines, too.

China has extended swap lines to about 40 central

banks, but some researchers believe this network is

primarily used by countries who have difficulty

borrowing in international markets.

China does have its own swap lines, and it has built a

very broad network that is completely in parallel to

the dollar system that we all have been relying on for

several decades.

Swap lines with other countries wouldn't be that

effective. But coming from the fed, it goes a long

way.

In helping other countries have attempted to avoid the

prominent US dollar with strategic monetary policies,

most notably in China.

In every single sector now, we're seeing Chinese

companies really compete and win.

It's not Nike or Adidas, you know, it's it's Li Ning

and other companies in China.

We know this story. It's BYD, it's not Tesla.

The flood of EVs that we see coming out of China is a

direct result of the fact that China has become debt

saturated and can't use its previous growth model to

just increase investment, increase leverage.

If they're following this growth model, then they have

to rely more on on exports.

At the same time, the other side of the dichotomy is

that they want to internationalize the renminbi.

The renminbi is also known as the Chinese yuan.

This currency accounts for 4.3% of payments made

globally that shares rising, but it's far behind the

use of dollars or euro, according to the Federal

Reserve.

It doesn't take off by itself because China lacks the

sort of the natural economic reasons why you would

want to sort of hold in that currency, but it starts

to take off when when the dollar becomes weaponized,

as it was against Russia.

I think another thing I'd say that's happening is this

movement towards central bank digital currencies.

Yuan is an example of that.

Can any of these replace the dollar?

Certainly not in the near term.

But at the same time, I would say dollar assets used

to be somewhere about 70%.

And they've declined from 70% in 2000 to now 60%.

So you see some chipping away happening.

But I always come back to what is the alternative.

Who's the heir. And I don't think there is any

apparent heir to to the throne right now.