Global Finance Connect | interview with Cheng Shi, chief economist of ICBC International: The Fed's interest rate hike cannot cure the root cause but can alleviate the economic pain caused by the supply shock

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21st Century Business Herald reporter Hejia reported from Beijing

Since last week, a number of Fed officials have made hawkish remarks, and market concerns have heated up, leading to a rapid strengthening of the dollar. The euro's exchange rate against the dollar hit a new 20-year low. This week, investors focused on the annual meeting of global central banks in Jackson Hole, looking forward to getting more clues about the Fed's policy path. At what pace will the Fed raise interest rates in the future? What spillover effects will a stronger DOLLAR have? Can the dollar rally be sustained? Around these issues, Global Finance Connection interviewed Cheng Shi, chief economist of ICBC International.

The Fed's rate cut could be as early as the second half of next year or the year after

Global Finance Connect: The market is focusing on the Jackson Hole meeting, looking forward to getting more clues about the Fed's policy path, what is your judgment on the pace of the Fed's interest rate hikes? What do you think of the argument that the Fed will turn to rate cuts in the coming months? In which case will the Fed pause rate hikes?

Cheng Shi: The Global Central Bank Governors' Meeting is remarkable every year because it provides not only possible information on policy changes in the world's major central banks, but also academic guidance on the long-term decision-making ideas of central banks. In other words, the speech of the governor at the meeting of central bank governors does not necessarily explicitly say "what I will do", but basically explains in detail "why I am going to do this". This time is no exception, and Powell's speech is very concerned by the market.

On the question of the Fed's rate cut, my answer is that the Fed will definitely cut interest rates in the future, but not in the next few months, as early as the second half of next year, or the year after.

Regarding the toss of raising interest rates first and then cutting interest rates, I think we need to dialectically understand that the biggest reality of the current global economy is that the new crown epidemic has caused a supply shock of magnitude of 40 years, and every supply shock in history has inevitably caused "stagflation", that is, economic growth stagnation and inflation coexist. This great reality means that the economic world has been fragmented, and when the two goals of economic growth and price stability go wrong at the same time, all policymakers face the dilemma of "pressing the gourd and floating the scoop". That is to say, policymakers can only focus their attention and policy resources on one problem for a period of time, and then they have to work non-stop to solve another problem that has been exacerbated by previous policies.

Stagnation and inflation are two sides of the same coin in the real world, whichever side faces up will solve the problem first. For the United States, the current inflationary pressure is unprecedented and urgent, and the pressure of stagnation is not so prominent compared to the current, so the Fed has raised interest rates quickly first, and the reason why it has continuously used 75 basis points to raise interest rates is also to solve the inflation problem as soon as possible, and then have more time and space to solve the recession difficulties.

Therefore, under the dual pressure of stagflation, the Fed is bound to need to raise interest rates first, then ease, and then cut interest rates to coordinate the balance between stagnation and inflation, this process seems to be somewhat repetitive, but the macro economy is always the lesser of two evils, in the complex situation that has not been encountered in 40 years, the Fed's policy choices will not be stuck in the clichés. Once inflation is effectively suppressed in the future and recession pressures continue to increase, the Fed will also weaken the tightening efforts. In reality, the probability of a recession in the United States is rising, and inflation data has peaked and fallen, so the Fed will slightly reduce the rate hike at the September meeting as soon as possible, and now the market believes that there is a half probability of thinking that the rate hike is 50 basis points, and the other half probability is still 75 basis points.

It is worth noting that anything, if it cannot be sustained for a long time, then it is bound to come to an abrupt end at some point in time. The Fed's interest rate hike and balance sheet reduction must have such a point in time. In my opinion, the pause button of the Fed's interest rate hike will be pressed when the benchmark interest rate reaches about 4-5%, and the pause button of the balance sheet will be pressed in 2025. The Fed has raised interest rates four times in March, May, June, and July this year for a total of 225 basis points, and in the next 3 meetings, September, November, and December, if the average increase of 50 basis points each time, will raise interest rates by a total of 375 basis points for the whole year, and the benchmark interest rate is 3.75-4%, which is actually close to the restricted area of the benchmark rate, so it will slow down next year until the hike is suspended.

Monetary policy is "space for time"

Global Finance Connect: Nobel laureate in economics Stiglitz said that the Fed's excessive interest rate hike may exacerbate inflation, do you agree?

Cheng Shi: Nobel laureate economist Joseph Stiglitz said that the central bank's aggressive interest rate hikes to curb supply-driven inflation risk exacerbating price increases. His point: "Raising interest rates doesn't solve supply-side problems, and it could even make the situation worse because what we need to do now is to invest more in supply-side bottlenecks, but raising interest rates will make those investments more difficult." "How will the hike bring more food, more energy, and solve the chip supply problem?" "They won't solve the basic root cause of the problem," Stiglitz said, "and the real risk is that the situation will get worse."

I think that Stiglitz's views are partly correct, they are true in the academic part, and too absolute in the realistic part. Inflation has four main causes: demand-induced, cost-driven, expected-induced and currency over-issuance, the current inflation is mainly a mixture of the latter three, especially cost-driven, this cost has two, one is raw materials, the other is people, commodity prices soared so far last year and Rising wages in Europe and the United States is indeed the core cause of current inflation, from this point of view, Stiglitz's view is accurate, cost-driven inflation is difficult to change by monetary policy. I think that monetary tightening cannot cure inflation, but it can alleviate inflationary pressures and curb the irrational upward movement of inflation and run out of control; Interest rate hikes can not cure the root cause, but can cure the symptoms, alleviate the economic pain caused by the supply shock, the final solution of inflation still needs to change the supply level, that is, the supply chain tension caused by the epidemic and the slow flow of factors are fundamentally solved, before that, monetary policy is to exchange space for time, and use the space of interest rates to exchange for time out of the supply shock. I think from this point of view, Stiglitz's view seems to be somewhat absolute, too idealistic and academic. Of course, his words deserve caution, that is, monetary policy also needs to be prudent, and monetary policy is not a panacea.

The euro will continue to weaken in a trend

Global Finance Connect: Recently, as the US dollar continues to strengthen, non-US currencies such as the euro and the japanese yen have depreciated sharply. Which economies do you think are more sensitive to a rise in the dollar index?

Cheng Shi: In fact, major currencies are more sensitive to the US dollar. If we look at it from a fundamental point of view, currencies with the following characteristics are more sensitive to changes in the exchange rate against the US dollar: First, the currencies of countries that have more economic and trade exchanges with the United States; The second is a currency with relatively high vulnerability, that is, a national currency with poor economic fundamentals, a relatively high fiscal deficit rate and a relatively high national debt ratio, and a relatively serious economic imbalance; The third is the currency of the commodity exporting country; Fourth, the national currency with relatively high us dollar foreign debt.

Global Finance Connect: The euro has fallen below parity against the us dollar again, will the weakness of the euro become a long-term trend? What is the dilemma for the ECB in formulating policy?

Cheng Shi: We think the euro will still weaken in a trend. First, the shadow of the debt crisis is shrouded, and the growing risk of stagflation in the euro area is exacerbating the imbalance between fiscal balances and payments, although this is not enough to lead to a substantive debt crisis, but the strengthening of debt risk expectations may weaken the euro's continued strength. Second, Europe's competitiveness is declining, affected by the conflict between Ukraine and Russia, energy prices have penetrated the eurozone trade chain, the eurozone terms of trade index shows that the eurozone terms of trade since entering 2022 is gradually deteriorating, negative income effect will stimulate the eurozone's purchasing power to shift to other global markets. Third, the current policy action is difficult to be effective, and even brings deeper problems, and the ECB's medium- and long-term suppression of overall inflation is limited. For countries in southern Europe, where consumption is weaker and debt is high, higher interest rate hikes mean higher debt and financing costs. This is why the bond yield spreads between the peripheral and core members of the eurozone have widened significantly after the outbreak of the Ukrainian-Russian crisis. Widening spreads have further led to fears of a new eurozone debt crisis, with "the euro never overcoming fundamental design failures that would lead to centrifugal forces between the core and peripheral countries erupting at any time". The dilemma faced by the ECB in formulating policy, which I summarize as: the dilemma of stagnation and inflation; The dilemma of north and south; The economic and political dilemma; The short-term and long-term dilemma. It's all hard.

The risk of global defaults has risen significantly

Global Finance Connect: As the Fed continues to tighten policy and the debt burden continues to increase, will this lead to panic in US financial markets?

Cheng Shi: The debt burden of the United States is indeed increasing, from 100% to nearly 140%, and judging by the current reflection of financial markets, there will be concerns, but not panic. The main concern is that the cost performance of continuous debt is decreasing significantly, and the US debt ratio is close to the critical point of 145%, after this point, the overall economic effect of continued debt does not increase but decreases, which is more negative for the US economy facing the threat of recession. The reason why I am worried but not panicked is mainly because the risk of default in the United States is still very small, the debt burden is large, but the solvency of the US economy is still very strong, and the global liquidity of the US Treasury bond market is still good.

Global Finance Connect: At present, central banks are using foreign exchange reserves to defend their currencies, especially some emerging markets are consuming foreign exchange too quickly, are they facing a greater risk of debt default? Will the 1997 financial crisis repeat itself for Asia?

Cheng Shi: At present, under the overall pressure, the global default risk has increased significantly at the level of national sovereignty and micro-enterprises. However, at present, on the whole, it will not lead to a financial crisis similar to that of 1997, which is currently a holistic weakness, and the local tipping point has not yet appeared.

The renminbi remains stable under two-way fluctuations

"Global Finance and Economics Connection": At present, the monetary policy differentiation between China and the United States and the intensification of the inversion of the Sino-US interest rate differential will affect the RMB exchange rate? Will the pressure on capital outflows increase?

Cheng Shi: The monetary policies of China and the United States are indeed divergent at present, with the United States accelerating interest rate hikes and China cutting interest rates and reducing the reserve requirement. I think that superficial differences are still subject to the general logic of unification. The big global logic is that the COVID-19 pandemic has caused one of the worst supply shocks of the past four decades, and supply shocks are bound to lead to stagflation, that is, the coexistence of stagnant economic growth and inflation. China and the United States are facing the pressure of stagnation and expansion at the same time, slightly different is that the current pressure center of gravity in the United States is more in inflation, and China is in the center of gravity, so the short-term direction of Sino-US monetary policy is not the same, but under the overall pressure of global stagflation, Sino-US monetary policy will be more prudent in their respective channels, the superficial differences are limited to the surface, and the internal policy logic is still unified. Because of this, the change in spreads has not led to excessive depreciation of the RMB exchange rate and rapid outflow of capital, on the whole, the RMB exchange rate has maintained stability under two-way fluctuations, and global capital still maintains enthusiasm for investing in China.

Planner: Yu Xiaona

Producer: Shi Shi

Reporter: Hejia

Responsible editors: Du Hongyu and Jia Zhao Yue Li Yinong

Producer: Li Qun

Design: Lin Junming Intern Liu Xueling

Trainee reporter: Hao Jiaqi Zhang Yuzhen

New media coordinator: Ding Qingyun, Zeng Tingfang, Lai Xi, Huang Daxun

Overseas Operations Producer: Huang Yanshu

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