Fed rate hike threatens to ‘break’ money markets

A man exchanges US dollar bills at an exchange office.

Muhammad Semih Usurulu | Anadolu Agency | Getty Images

As the dollar rose to a 20-year high against a wide number of major foreign currencies, the historical specter of the forex market crisis loomed large.

While now largely all but forgotten, those of us who covered the event, a US dollar boom in 1985, are now entering the way-back machine, pushing the then G-5 industrialized countries into the money market. forced to intervene and significantly weaken the dollar.

At a September meeting in Manhattan, G5 announced the “Plaza Accord” (designed at New York’s iconic Plaza Hotel) and coordinated steps to undermine the greenback, selling dollars on the open market while the US cut interest rates to reverse the dollar. meteoric rise.

The goal was manifold – to relieve tensions from a then-rigorous foreign exchange trading system, in which many global currencies were pegged to the dollar, to make US goods less expensive in foreign markets amid a growing US trade deficit, and to coordinate global interests. Rate policies to synchronize world economic cycles.

Similarly, in late 1994, 1997 and 1998, a rising dollar caused much trouble not only in the foreign exchange markets but also in the global economy.

In short, although this was a more complicated event on the Mexican side of the border, as the Fed tightened policy in 1994 to cool the US economy, the Mexican peso crashed against its lower peg against the dollar, Due to which Mexico was forced to give up the linkage. , sending pesos in freefall that year.

Once the link was broken, Mexico faced massive inflationary risks, as the peso fell against the dollar. The US actually lent Mexico $50 billion in cash to correct its economic shipwreck, as inflation reached 52% south of the border.

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It was one of the precipices that forced the Federal Reserve to stop raising rates in the worst year for US bond markets in decades.

Again, in 1997, the Asian currency crisis and, in 1998, Russian debt defaults (and the associated collapse of hedge fund Long-Term Capital Management) forced the Fed to either delay raising rates or cut them in ’98. . Systemic financial risk due to the latter event.

In both cases, global currencies were in turmoil, markets melted, and the Fed was forced to either halt planned rate hikes, or cut them abruptly, reducing the increased risk of foreign economic infections. To do so, which could have decimated the US economy as emerging markets collapsed. ,

We are approaching another similar pain point today, which The Fed’s aggressive interest rate hikes This creates further tension in the forex markets, which, in turn, can lead to both increased global market and economic risk.

As of today, the British pound is at its lowest level against the dollar since 1985. The euro sells for less than $1 in foreign exchange markets, while weakness in the Japanese yen, at a 24-year low against the greenback, propelled the bank. Japan intervened to support its currency for the first time since 1998.

Emerging market currencies are under similar pressure, threatening a currency crisis that could once again disrupt global financial markets, which are already in a worldwide downtrend, and force the Fed to change policy. Is.

this form fights inflation at homeBy raising interest rates and tightening debt positions at the fastest pace in decades, the Fed is exporting inflation to other countries and making American goods more expensive in foreign export markets.

In addition, a stronger dollar cuts into the repatriated profits of US multi-national corporations, putting corporate earnings at risk even more in an already weak US and global economy.

In any policy effort, there are risks and rewards, with both acceptable, and unacceptable, trade-offs.

We are now reaching an unacceptable point.

Witness a sharp jump in global interest rates, an extremely rapid appreciation of the dollar and a parallel decline in global equities.

I’ve said for a long time that the Fed will raise rates until something breaks. You are hearing the sound of market breakdown today.

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