Column by Tatyana Edovina on the unusual impact of global risks on monetary policy

The latest data on the state of the American labor market most likely confirms the fears of market participants about the need for a further increase in rates: statistics from the country’s Ministry of Labor showed that 336 thousand jobs were created in September against the expected 170 thousand (this is the largest increase since January, in August 227 thousand were created), and the unemployment rate remained low – 3.8%. Let us remind you that at the September meeting of the US Federal Reserve refrained from raising the rate, keeping it at 5.25–5.5%, and the head of the regulator, Jerome Powell, said that the state of the economy, including consumer activity, exceeds expectations, while in the fight against inflation the regulator needs to see confirmation that the level of rates is sufficiently restrictive. So far, the Fed obviously doesn’t see this: the updated forecast calls for a decline in inflation in the US this year to 3.3% (versus 3.2% in June) with economic growth of 2.1%, not 1%.

The latest statistics do appear to confirm a surge in economic activity in the third quarter after a slight slowdown in the first half of the year. For monetary authorities, this means one thing – rates should remain at high levels longer than expected. The shift in expectations is also noticeable in bonds: 10-year yields are approaching 5%, the highest since 2007. In the first half of the year, yields declined in anticipation that the tightening cycle was about to end and rates would go down. However, a reduction in fiscal spending can also limit growth.

Note that professional analysts cited by the IMF expect inflation levels to return to target levels no earlier than 2026 on average. By this point, the Central Bank rates may also return to neutral (that is, not stimulating or cooling the economy) levels. However, it is not possible to reliably determine the level of the neutral rate. This is why the same interest rate may be too high in one period and too low in another. In the current environment, however, higher rates reflect higher risks. This usually applies to assets in emerging markets, where higher returns justify the national characteristics of doing business, but now the main risks are global. This can be represented as follows: uncertainty and various supply constraints can increase inflation expectations, which, in turn, affect actual inflation (and require higher rates). In this connection, any military conflicts and prospects for increased military spending increase the level of the neutral rate (through a reduction in available capital), and increased inflation expectations lead to an increase in real rates.