Central Banks Caught Between Commodities Slump and Fed Hike

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The central banks of New Zealand and South Africa, both commodity-producing countries, oversee economies under pressure from the weakest raw-material prices in 13 years.

The similarity ends there. Milk exporter New Zealand cut interest rates on Thursday for the second time in six weeks and Governor Graeme Wheeler signaled more easing to come. Metals-rich South Africa raised its benchmark.

Around the world, rich producers including Canada and Australia are injecting fresh stimulus or keeping rates low. Emerging markets such as South Africa and Brazil, hamstrung by faster inflation and the need to protect their currencies from the effect of higher U.S. rates, are holding fast or raising borrowing costs.

“Central banks in commodity-exporting countries do want to cut if the fundamentals permit, but not everyone has that flexibility,” said David Hensley, director of global economics for JPMorgan Chase & Co. in New York. “In the emerging markets there’s just not much room.”

The effects of cheaper raw materials have been rippling through the global economy ever since oil entered a bear market last year. Now metals and crops are falling too because of a slowdown in China, the biggest consumer, and a stronger U.S. dollar, the currency in which most materials are denominated. The Bloomberg Commodity Index extended its decline to a 13-year low on Friday and is set for a third weekly loss.

The typical response of central banks to such a deflationary shock would be to cut borrowing costs. Bread alone accounts for more than 1 percent of consumer prices in Brazil, and wheat futures are down 12 percent this year. New Zealand is suffering from zero inflation after a plunge in whole milk powder prices to the lowest since July 2009.

Slowing Exports

The more a country depends on commodities, the slower its exports grew last year, Citigroup Inc. said in a report this week. Argentina, Russia and Indonesia were among the countries whose commodity exports account for more than 50 percent of total shipments and whose overall exports shrank last year.

New Zealand isn’t the only rich producer opting for stimulus. The Bank of Canada last week reduced its benchmark for a second time this year as the slump in oil, the country’s chief export, threatens recession.

Reserve Bank of Australia Governor Glenn Stevens said rate cuts remain “on the table.” The central bank already cut rates twice this year as a decade-long mining boom ends in the world’s biggest exporter of iron ore and coal.

“If we were to see commodities prices take new legs lower across the complex, then we would have to think seriously about new risks,” said Paul Christopher, head global market strategist at Wells Fargo. “All things equal, you should expect more monetary stimulus going forward.”

Currency Pressure

Not all things are equal, though. For emerging markets, the looming rate increase from the Fed threatens a flight of capital, pressuring their currencies and therefore limiting room to ease monetary policy. That’s what happened in 2013, when the Fed was preparing to slow its bond-buying program.

Inflation is also more of a factor in the developing world. In Brazil the rate is now more than 9 percent and in South Africa it threatens to exceed the central bank’s target. Capital Economics Ltd. reckons inflation across emerging markets hit a low of 4.6 percent in May and will soon accelerate, in part because oil won’t fall as far as last year.

Having cut rates by an average 60 basis points this year, central banks in emerging markets are now unlikely to cut by more than 40 basis points, and whether they can depends on the fallout from the Fed, according to JPMorgan’s Hensley. He predicts Brazil and Mexico will join South Africa in raising benchmarks.

“It’s understandable as EM currencies have been hurt a lot in every Fed hiking cycle,” said Ilan Solot, emerging markets currency strategist at Brown Brothers Harriman & Co. “There’s nervousness ahead of the Fed move so most will prefer to wait and see.”