Are Emerging-Market Investors Heading for the Exits?
What the end of Yellen’s patience on interest rates means for smaller economies.
Federal Reserve Chairwoman Janet Yellen cleared the way for the end of the Fed’s zero-interest rate policy Wednesday, a move that could roil emerging economies like Turkey and Brazil.
In a statement issued after a two-day meeting in Washington, the central bank dropped previous assurances that it would be “patient” when it came to deciding to raise interest rates, which hasn’t happened since 2006. The Fed was careful to note in its statement that the bankers hadn’t decided on the “timing of the initial increase” and would be watching the economic data to determine when they would act.
In a press conference, Yellen said the change “does not mean we are going to be impatient” when it comes to the timing of a rate increase.
“Our actual policy actions over time will be data-dependent,” she said.
The Fed has long telegraphed its intentions to back away from the low interest rates put in place to spur the sluggish U.S. economy after the 2008 financial crisis, but some economists fear there could still be a reckoning coming for small, faster-growing countries that attracted a lot of investment while the U.S. economy was in the doldrums.
IMF Managing Director Christine Lagarde warned of the risks Tuesday in Mumbai at a press conference with the head of the Reserve Bank of India.
“Even if this process is well managed, the likely volatility in financial markets could give rise to potential stability risks,” Lagarde said.
After the U.S. economy was plunged into recession in the wake of the 2008 financial crisis, the Fed started buying bonds from banks, effectively pushing money into the U.S. financial system to hold down borrowing costs and to try to get banks to lend and, in turn, businesses and individuals to spend. But the money didn’t all stay inside U.S. borders. In the face of low interest rates on safer assets in the United States, people looked for investments overseas that, while more risky, provided higher returns.
In May 2013, when the Fed first signaled that it would slow or “taper” its bond-buying stimulus program, investors dumped emerging-market assets in a widespread sell-off that became known as the “taper tantrum.”
Tens of billions of dollars fled these smaller, riskier markets, causing currencies to plummet, some as much as 20 percent. Now, the concern is that rising interest rates could again spark a similar investor rush for the exits.
“I am afraid this may not be a one-off episode,” Lagarde said Tuesday.
Lagarde and others are worried that investors, presented with the return of higher rates of return on U.S. assets, could suddenly pull out of these smaller industrializing economies, which could again wreak havoc on local currencies. Some see indications that it’s happening already.
“There are signs that investors are starting to throw yet another fit — since the beginning of March we’ve seen emerging-market stocks sell off roughly 4 percent,” said Nicholas Spiro, a sovereign-debt analyst in London.
In addition, higher U.S. interest rates would strengthen the dollar, making it harder for countries and companies that borrowed in dollars, when it was cheap, to pay back their debts.
But the Fed isn’t the only game in town. The European Central Bank announced in January that it would follow in the footsteps of the United States, Britain, and Japan by buying bonds in order to jump-start lending, investment, and, hopefully, overall growth in Europe.
Gabriel Sterne, head of global macro investor services at Oxford Economics Ltd. and a former IMF and Bank of England economist, said emerging-market stocks, bonds, and other assets will likely fall in value if the United States raises rates, but that the European Central Bank’s stimulus program will dampen the effect.
“The European Central Bank is pouring liquidity into markets, so that will filter through to emerging-market asset prices,” said Sterne.
Whatever the effect of a Fed move might be on India, Brazil, or Turkey, it’s not supposed to be part of the Fed’s decision-making process. The Fed has a dual mandate of maximizing U.S. employment and holding down U.S. inflation — worrying about emerging markets isn’t part of Yellen’s job description. Still, she said, a healthy U.S. economy is a boon for everyone.
“A strong U.S. economy certainly is something that is good for other countries as well,” Yellen said Wednesday.
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