Unwinding the Carry Trade: Navigating Structural Shifts, Diverging Fed Policy Views, And The Role Of CEDAR In Transparent AI Governance
Birgul COTELLI, Ph. D.
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The unwinding of the carry trade, a critical force in global financial markets, signals deeper structural shifts that policymakers must navigate with caution.
As interest rate differentials narrow and geopolitical tensions rise, market volatility is likely to persist. Federal Reserve policymakers, while united in their recognition of the need for rate cuts, hold differing views on the underlying reasons and the path forward, reflecting a broader debate on economic strategy.
At the same time, technological advances like the CEDAR initiative—fostering Common European Data Spaces and AI transparency—are shaping governance frameworks, emphasizing the growing role of AI in public policy.
Together, these developments underline the complex, evolving landscape that policymakers face in maintaining economic stability and governance integrity.
Unwinding The Carry Trade: Navigating Structural Shifts In Global Markets
The global financial landscape has experienced significant volatility, driven largely by the unwinding of carry trades. While temporary market dislocations are common, the structural factors behind these movements persist, suggesting that further market disruptions could be on the horizon. The carry trade unwind, where investors borrow in low-interest-rate currencies to invest in higher-yielding ones, has long been a pillar of international finance. However, recent developments—ranging from shifting interest rate differentials to geopolitical uncertainties—have led to pronounced movements in currency and asset prices.
One of the key elements influencing market volatility is the evolution of external statistics in an increasingly fragmented global economy. As international economic relations grow more complex, the need for accurate and timely external statistics becomes even more urgent. These statistics not only inform policymaking but also help market participants better understand the risks and opportunities in cross-border trade and investment. In a world where economic and geopolitical tensions are rising, external statistics must be agile enough to reflect these changes.
Project Keystone, a forward-looking initiative, aims to enhance the use of data analytics within the framework of ISO - International Organization for Standardization 20022, an international messaging standard for financial institutions. By leveraging technology, Project Keystone seeks to make ISO 20022 data more analytically useful, which could play a critical role in managing the risks associated with the carry trade unwind. Advanced analytics will help policymakers and market participants make sense of the massive amounts of financial data generated globally, improving decision-making in uncertain times.
Meanwhile, the Bank for International Settlements – BIS has introduced a new historical data set on central banks' balance sheets, offering valuable insights into how central banks have responded to economic shocks over time. Understanding the size and composition of central banks' balance sheets is crucial for gauging their ability to manage future financial crises, particularly as global inflation dynamics remain a central concern.
On the inflation front, BIS has released a study marking sixty years of global inflation, exploring the extent to which recent inflation trends are part of a broader global phenomenon. The interconnectedness of economies means that inflation is no longer a purely domestic issue but a challenge that requires global cooperation and insight.
Additionally, permissionless distributed ledger technologies (DLT) are introducing novel risks for banks, particularly when it comes to regulatory compliance and data security. A recent BIS working paper explores how financial institutions can mitigate the risks of transacting on such technologies, emphasizing the need for robust safeguards and innovative strategies. As the use of DLT grows, especially in areas like decentralized finance (DeFi), understanding these risks will be paramount for maintaining stability in financial markets.
Finally, global real house prices declined by 1.0% in Q1 2024 compared to the previous year, although many economies saw increases. This divergence reflects broader economic trends, including differences in monetary policy and housing demand. At the same time, the effects of low interest rates on banks’ exposure to interest rate risk are coming under increasing scrutiny. A BIS working paper dives into whether low rates are now "firing back" by complicating the transmission of monetary policy, especially in an environment of rising rates.
As the world grapples with new economic challenges, these developments highlight the importance of evolving financial strategies and policies to manage novel risks and ensure stability in an unpredictable market environment.
Fed Policymakers Agree On Need For Rate Cuts, But Their Reasons Vary
As the U.S. Federal Reserve Board implements its first rate cut in years, policymakers are increasingly aligned on the need to lower borrowing costs. However, despite broad agreement, their motivations vary, reflecting deeper concerns about inflation, labor markets, and the overall economy. This diversity of perspectives underscores the complexities faced by policymakers in navigating today’s economic landscape.
A Unified Decision, But Varied Reasons
As of September 2024, nearly all Fed officials agree that inflationary pressures are subsiding, a significant shift from earlier in the year when many were not expecting rate cuts at the September 17-18 meeting. What pushed them toward consensus was a broad array of economic data, which pointed to cooling inflation and signs of a slowing labor market.
Yet, while the collective move toward rate cuts is clear, the rationale behind it differs across the board. Some policymakers, like Boston Fed President Susan M. Collins, emphasize a "methodical" and cautious approach, focusing on inflation’s downward trajectory while maintaining confidence in a resilient labor market. For Collins and others, like Philadelphia Fed President Patrick Harker, the main risk is premature action—advocating for small, steady cuts to avoid disrupting the economic recovery.
On the other hand, labor market dynamics weigh heavily on figures like San Francisco Fed President Mary C. Daly. While she acknowledges that inflation is cooling, Daly is more concerned about potential downturns in employment. According to Daly, maintaining a strong labor market should be the central focus, especially since recent slowdowns in job gains haven’t yet triggered layoffs, signaling a “low-hiring, low-firing” environment. However, she warns that this balance is fragile, and should unemployment rise, more aggressive rate cuts may be required to prevent a more severe economic downturn.
The Risks of Over- or Under-Reaction
Richmond Fed President Tom Barkin and other policymakers express concerns about the unpredictability of the current economic environment. Barkin’s assessment of the labor market’s “low-hiring, low-firing” mode reflects the challenge: should hiring decline too much without an uptick in layoffs, economic stagnation may become a real threat. In such a scenario, the Fed risks acting too late or too timidly, leaving the economy exposed to greater risks.
Fed Governor Adriana Kugler and Christopher Waller, both labor economists, highlight the critical point where job openings fall below the number of job seekers, a development that could soon drive unemployment higher. This tipping point serves as a key metric for these policymakers as they assess whether the labor market remains resilient or begins to falter. For them, maintaining flexibility in monetary policy is essential to responding to potential threats.
Balancing Data with Ground-Level Feedback
Voices from business and regional markets are also playing a critical role in shaping the Fed’s thinking. Atlanta Fed President Raphael Bostic, for instance, revised his earlier forecast of a single rate cut in the fourth quarter to advocate for an earlier reduction. His shift came after hearing from business leaders in his district, who expressed growing concerns about the economic toll of rising borrowing costs. Bostic’s perspective illustrates how policymakers are balancing national economic indicators with regional and sector-specific concerns to form a comprehensive view of the economy.
Similarly, Chicago Fed President Austan Goolsbee draws attention to a widening gap between the Fed’s policy rate and actual borrowing costs. With inflation cooling to 2.5%, he argues that keeping rates high could unnecessarily constrain economic activity, leading to unintended damage in both the job market and overall growth. For Goolsbee, the Fed’s challenge is to ensure that monetary policy doesn’t overcorrect, choking off growth at a time when inflation is already under control.
Charting a Course Forward
Fed policymakers must navigate a fine line between acting decisively to lower borrowing costs and avoiding premature moves that could further complicate the economic picture. With inflation cooling, but labor market risks looming, the Fed's next steps do depend not only on incoming data but also on the diverse interpretations and policy preferences of its decision-makers.
Ultimately, the ability of Fed Chair Jerome Powell (federalreservehistory.org/people/jerome-h-powell) to bring together these differing perspectives will be key in shaping U.S. monetary policy. His role as a consensus-builder will be tested as the Fed attempts to manage a soft landing for the economy—one that addresses inflation, preserves labor market health, and avoids triggering a broader downturn. This multifaceted approach to policymaking highlights the complexities of navigating today's global economic environment, where data, uncertainty, and regional dynamics all play a critical role in decision-making.
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CEDAR: Common European Data Spaces And Robust AI For Transparent Public Governance
The Common European Data Spaces for Transparent Public Governance (CEDAR) project is poised to revolutionize how public funds are managed and protected across Europe. Launched in January 2024 as a 36-month initiative funded by Horizon Europe (research-and-innovation.ec.europa.eu/funding/funding-opportunities/funding-programmes-and-open-calls/horizon-europe_en), CEDAR aims to harness the power of high-value datasets, artificial intelligence (AI), and big data technologies to create a more transparent, accountable, and corruption-resistant governance system. With 31 partners spanning various disciplines, the project seeks to address some of the most pressing governance issues by building secure data-sharing networks and developing advanced analytics for public administration.
CEDAR’s Mission and Impact
At its core, CEDAR is designed to enhance and combine existing Common European Data Spaces (CEDS) with new datasets that can be used to develop solutions for better decision-making in public governance. By integrating diverse data sources, digitizing archives, and generating synthetic datasets, CEDAR will provide a unified data repository that allows for secure and seamless data access. This effort will not only improve governance processes but also align with broader European strategies such as the European Data Act and the European Strategy for Data.
The project's primary focus is on promoting transparency, combating corruption, and reducing fraud in public administration. Through its innovative use of technology, CEDAR seeks to protect public funds and improve the management of essential services, from public procurement to healthcare.
Leveraging AI and Big Data to Combat Corruption
To achieve these goals, CEDAR is deploying state-of-the-art technologies, including advanced AI, machine learning (ML), and natural language processing (NLP). By analyzing large volumes of multilingual text, multimedia data, and financial transactions, CEDAR will uncover patterns indicative of corruption or fraud. Video understanding technologies, deep fake detection, and advanced audio processing will enhance the integrity of public records and support real-time monitoring of public procurement and spending.
Additionally, CEDAR’s infrastructure is built on secure DataOps and MLOps frameworks, ensuring that data connectors and APIs across European data spaces are interoperable, reliable, and secure.
Key Use Cases: Italy, Slovenia, and Ukraine
CEDAR is validating its approach through three high-impact pilot projects in Italy, Slovenia, and Ukraine, each focusing on a different aspect of public fund management.
Enriching Europe’s Data Ecosystem
CEDAR’s contributions go beyond immediate governance challenges. By improving data access, harmonization, and security, the project is enhancing Europe’s overall data ecosystem. The advanced data analytics tools developed under CEDAR will empower public administrations to make evidence-based decisions, further solidifying Europe's position as a leader in digital governance and data-driven policy.
Conclusion
With its ambitious vision and cutting-edge technology, CEDAR is set to reshape public governance across Europe. The project’s focus on transparency, accountability, and data-driven decision-making is a critical step in addressing corruption and inefficiencies, fostering a more just and robust governance system. As CEDAR progresses, it will not only contribute to safeguarding public funds but also enrich the European data landscape, promoting digital sovereignty and enhancing public trust in governance.
Conclusion
In conclusion, the convergence of global financial market shifts, such as the unwinding of carry trades and the narrowing of interest rate differentials, with technological advancements like the CEDAR initiative, presents policymakers with a complex landscape.
As they navigate the economic turbulence driven by inflation, labor market dynamics, and geopolitical tensions, it is essential for them to leverage emerging technologies like AI and big data to bolster governance integrity.
The CEDAR project, with its focus on transparency, secure data sharing, and real-time monitoring, underscores the importance of integrating innovative solutions into policy frameworks. This approach not only enhances decision-making but also strengthens public trust and accountability—cornerstones of effective governance.
As policymakers continue to face unprecedented challenges, fostering collaborations between technological innovation and economic strategy will be key to maintaining stability and transparency in the global financial system.
Sources: Bis.org Reuters.com Innovationnewsnetwork.com
Federalreservehistory.org Federal Reserve Board ISO - International Organization for Standardization Bank for International Settlements – BIS Bostonfed.org Philadelphiafed.org frbsf.org Richmondfed.org Atlantafed.org Chicagofed.org
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