Forex News – Emerging Markets face market turbulence as Fed tapering progresses
January 29, 2014 1:50 pm
One side-effect of the Federal Reserve’s super-easy monetary policies of the past 4 years or so, is that global markets have been flooded with extra liquidity. Many of the US dollars that the Fed has created found their way out of the United States and into a very diverse array of international assets. As investors looked for higher-yielding opportunities to replace their reduced income from U.S. fixed income investments, emerging market bonds were one obvious choice.
This was initially a beneficial development for a number of emerging market economies as capital flowed in. A country such as Brazil even had to implement restrictions on inflows of capital.
However, since it became apparent that the Federal Reserve will reduce its monthly amount of monetary stimulus, there have been some tremors in emerging market currencies and debt. New emerging market terms have surfaced after the original BRICs (Brazil, India, Russia and China) or the Next 11, there are now the ‘Fragile Five’ which represent Brazil, India, South Africa, Turkey and Indonesia.
The common thread between the ‘Fragile Five’ was that all of these countries benefitted from capital inflows that boosted their economic growth. Certain of these countries also had ran current account deficits that needed foreign capital inflows to support. If these capital inflows reversed, these countries could find themselves in trouble quickly.
As the second meeting of the Federal Reserve approached, there was intense pressure on a number of emerging markets; India, Turkey and South Africa were singled out in particular. In Turkey, the Central Bank decided on sharply higher interest rates during an emergency midnight meeting in order to defend the local currency. During its previous meeting as recently as January 21 it had decided against raising interest rates and instead tried – unsuccessfully – to defend the lira by using its foreign exchange reserves.
Turkey is an interesting case as the economy has grown rapidly in recent years but the ruling Erdogan government is facing political problems due to corruption investigations, while the current account deficit is at a relatively high level of 7% of GDP.
India and South Africa also raised their respective interest rates, although by much less than Turkey. Emerging market countries are vulnerable because of a variety of factors. Not only have they been huge beneficiaries of the Fed’s easy money policies, but some face political uncertainty, important structural problems (labor market rigidities, corruption, closed markets etc.) which they are unable to reform and unbalanced growth.
Problems in emerging markets have led to some sharp risk-off moves globally, as witnessed by the strengthening of the Japanese yen and the rise in the price of gold. The aussie has also been vulnerable during sell-offs, whereas the US dollar should in theory benefit as tapering proceeds. Volatility could also be higher.
One side-effect of the Federal Reserve’s super-easy monetary policies of the past 4 years or so, is that global markets have been flooded with extra liquidity. Many of the US dollars that the Fed has created found their way out of the United States and into a very diverse array of international assets. As investors looked for higher-yielding opportunities to replace their reduced income from U.S. fixed income investments, emerging market bonds were one obvious choice.
This was initially a beneficial development for a number of emerging market economies as capital flowed in. A country such as Brazil even had to implement restrictions on inflows of capital.
However, since it became apparent that the Federal Reserve will reduce its monthly amount of monetary stimulus, there have been some tremors in emerging market currencies and debt. New emerging market terms have surfaced after the original BRICs (Brazil, India, Russia and China) or the Next 11, there are now the ‘Fragile Five’ which represent Brazil, India, South Africa, Turkey and Indonesia.
The common thread between the ‘Fragile Five’ was that all of these countries benefitted from capital inflows that boosted their economic growth. Certain of these countries also had ran current account deficits that needed foreign capital inflows to support. If these capital inflows reversed, these countries could find themselves in trouble quickly.
As the second meeting of the Federal Reserve approached, there was intense pressure on a number of emerging markets; India, Turkey and South Africa were singled out in particular. In Turkey, the Central Bank decided on sharply higher interest rates during an emergency midnight meeting in order to defend the local currency. During its previous meeting as recently as January 21 it had decided against raising interest rates and instead tried – unsuccessfully – to defend the lira by using its foreign exchange reserves.
Turkey is an interesting case as the economy has grown rapidly in recent years but the ruling Erdogan government is facing political problems due to corruption investigations, while the current account deficit is at a relatively high level of 7% of GDP.
India and South Africa also raised their respective interest rates, although by much less than Turkey. Emerging market countries are vulnerable because of a variety of factors. Not only have they been huge beneficiaries of the Fed’s easy money policies, but some face political uncertainty, important structural problems (labor market rigidities, corruption, closed markets etc.) which they are unable to reform and unbalanced growth.
Problems in emerging markets have led to some sharp risk-off moves globally, as witnessed by the strengthening of the Japanese yen and the rise in the price of gold. The aussie has also been vulnerable during sell-offs, whereas the US dollar should in theory benefit as tapering proceeds. Volatility could also be higher.
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