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Central banks around the world are surprising markets with aggressive rate cuts: Here's why

Key Points
  • The main takeaway from the raft of monetary policy easing points to central banks signaling major concerns about the outlook for economic growth, and resorting to sharp monetary policy action in order to stave off a downturn.
  • The latest round of rate cuts, along with the trade war uncertainty, has seen investors rush to safer assets such as government bonds and gold.

Central banks in New Zealand, India and Thailand all announced larger-than-expected cuts to interest rates on Wednesday, furthering a global trend of monetary policy easing.

The Reserve Bank of India cut rates by 35 basis points for a fourth straight meeting this year, while the Bank of Thailand unexpectedly cut its rate by 25 basis points for the first time since 2015.

The Reserve Bank of New Zealand (RBNZ) stunned markets with a 50 basis point cut, twice the expected level, to take its official cash rate to an all-time low of 1%. The Reserve Bank of Australia, meanwhile, held rates at a record low following cuts in June and July.

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The main takeaway from the raft of monetary policy easing points to central banks signaling major concerns about the outlook for economic growth, and resorting to sharp monetary policy action in order to stave off a downturn. Central banks often resort to lower interest rates in environments like this in order to boost money supply in the economy, stoke demand and provide an impetus to growth.

Rabbani Wahhab, senior fixed income portfolio manager at London & Capital, told CNBC on Wednesday that the timing and size of the rate cuts from New Zealand, Thailand and India sends out a clear message to their respective economies and the rest of the world.

He further pointed out that the central banks are of the opinion that "it's not just the large economic blocs such as the U.S. and the euro zone that need easier monetary conditions, but other economies which are part of the global machine."

The key drivers for monetary policy loosening from central bankers are softening domestic outlooks, falling annual growth rates and expectations, low inflation and weakening business and consumer confidence.

Global long-term interest rates have declined to historically low levels to accommodate this, with the European Central Bank (ECB) citing these concerns as it hinted at a potential rate cut later this year, along with the U.S. Federal Reserve, which last month announced its first cut since the 2008 financial crisis. The regional headwinds are compounded at the moment, however, by the risks to global growth arising from the ongoing trade war between the U.S. and China.

"The common worry among global central bankers is disinflation, which in itself is often a precursor to slowing economic activity. This is the reason why we are likely to see more central banks move over the course of the next few weeks," Wahhab said.

Bond rally

The latest round of rate cuts along with the trade war uncertainty has seen investors rush to safer assets such as government bonds and gold.

Germany's bond yields are a prominent example, and they plummeted to fresh record lows on Wednesday. By mid-afternoon in European trade, the yield on the German 10-year bond was just off its earlier record lows at -0.5890%, while the yield on the 30-year bond tumbled to an all-time low of -0.117%.

Both edged slightly off the bottom during the afternoon but remain near historic lows, with the entire German government yield curve now in negative territory.

German government 10-year bond, an important benchmark for European fixed income assets, is viewed as a safe-haven for investors. In times of uncertainty and challenging market environment, investors tend to move their investments from riskier assets into safe-havens like gold and government bonds, thereby bumping up demand and prices. Bond yields move inversely to prices, and hence have been increasingly turning negative.

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Last Thursday's announcement by U.S. President Donald Trump that 10% tariffs would be imposed on an additional $300 billion of Chinese imports pushed the German 30-year yield below 0% for the first time ever, and triggered a mass sell-off in global stock markets. While stocks showed some signs of reprieve Wednesday, bonds continued to rally at record rates.

"Investors in this type of environment look to 'go up the yield curve', namely to buy long dated government bonds, both from a credit risk-free perspective as well as locking in nominal yields as a hedge against inflation moving lower," Wahhad explained.

"Many important investors such as insurance companies are almost forced into buying government bonds as their liabilities rise due to lower discount rates."

Bond yields, which move inversely to their prices, are tumbling worldwide. U.S. 10-year Treasury yields on Wednesday fell to their lowest since October 2016, while yields in the U.K., New Zealand and the Netherlands have also touched record lows in recent days.