QNB expects interest rates to remain high for longer, awaiting an additional 25 basis points increase in May by the US Federal Reserve – the US central bank – to bring the final federal funds rate to 5.25%.
In its weekly report, Qatar National Bank ruled out any interest rate cuts until at least 2024, despite continuing concerns about financial instability.
The report attributed this trend to two factors, the first of which is that despite the significant decline in inflation in recent months, from 9.1% in June 2022 to 6% in February 2023, conditions are still not favorable for the Federal Reserve Bank to achieve the target rate for inflation.
The report said that apart from the ongoing economic slowdown, US labor markets are currently still the narrowest in decades, and there must be a significant moderation in wage growth, which currently ranges between 5 and 6 percent, before inflation stabilizes at more appropriate levels. Therefore, it is important for the Fed to maintain its monetary tightening policy in order to allow for a gradual release in the labor market.
The second element indicated by the report is that adjusting the various monetary policy tools should provide space for the Fed to maintain a firm stance in combating inflation while managing the risks of financial instability.
The report believes that the discrepancy between the two goals is likely to lead to "Season" monetary policy tools. Unlike most central bankers in the past where they emphasized the need to align policy instruments, ie that official interest rates and the balance sheet should go in the same direction or at least should not contradict each other whether on easing, on neutral or on monetary tightening. This has led to rules for combining raising interest rates with maintaining balance sheet stability or decreasing them, as opposed to expanding the balance sheet, which increases the money supply and liquidity in the system.
The report pointed out that the Federal Reserve reaffirmed the need to adopt a different approach in applying monetary policy tools, according to which interest rate policy is the main tool to combat high inflation, while balance sheet policy will be adjusted, in a targeted manner, in order to support stressed financial markets. This will allow for a more orderly and sustainable process of adjusting monetary policy.
The report said that the US Federal Reserve is usually under pressure to ease or change very tight monetary policies, as investors and the general public prefer "easy winnings" or easy monetary conditions. High and rising interest rates can restrict economic activity, increase the cost of capital, and lead to sell-offs of long-term assets such as growth stocks, long-term bonds, and real estate.
The report noted the Fed’s implementation since March last year of one of the most powerful and unexpected monetary tightening cycles in US history. This led to negative surprises and significant declines in growth stocks (-9%), long-term treasuries (-19%) and US real estate assets (-22%). These declines underscore the need for a deeper study of the Fed’s monetary policy and its impact on financial stability.
In recent weeks, the first signs of financial instability began to emerge, the report said, as regional US banks that had large unrealized losses in their bond portfolios experienced large outflows of deposits. This lack of confidence has led to a run on deposits from more fragile institutions, such as California-based Silicon Valley Bank and New York-based Signature Bank. Then fears of contagion emerged, and the economic authorities had to intervene to cover deposits in full and open a new window for liquidity. The announced Bank Term Financing Program (BFTP) allows banks to deposit Treasury notes and other government debt securities with the Fed at their original rate, enabling lenders to avoid a forced sale and honor the deposit.
The report showed that financial instability has led to an increase in the debate about whether the Fed is ready "to stop" Temporarily refrain from raising or even lowering interest rates sooner rather than later. Given lower inflation expectations and weaker growth prospects, investors now believe that the Fed will cut interest rates in the second half of the year. Fed funds futures point to 100 basis points cuts in interest rates by January 2024. The report recalled the decision by Fed officials to raise interest rates by an additional 25 basis points, and importantly, Jerome Powell, the Fed chair, clearly stated that the task of Reducing inflation remains a priority and interest rates are expected to rise further.
