One of the most important things to grasp about the Fed’s September (in)decision is that the FOMC had no viable options when it came to emerging markets.
The combination of low commodity prices, falling demand, slumping global trade, a decelerating China, and the yuan devaluation have all served to accelerate capital outflows for EM and there’s certainly an argument to be made for the contention that a Fed hike and a subsequent spike in the dollar would be just about the last thing EM needs when it comes to stopping the bleeding.
That said, there’s another line of argumentation which says the Fed missed its window to hike long ago and so now, all they’re doing in the Eccles Building is fostering continued uncertainty which is also causing capital to flow out of EM.
In the simplest terms possible: no one really has any idea whether it’s best to rip the band-aid off or not, and adding to the confusion is the fact that the Fed has now telegraphed its own uncertainty by explicitly acknowledging the reflexivity problem, meaning EMs (and everyone else for that matter) are desperately trying to figure out how to incorporate themselves into their own outlook for what the Fed may or may not do.
Here’s how one former Treasury economist framed the latter argument:
”Short-end rates move higher as the Fed gets closer to hiking, and that causes the dollar to strengthen, and that causes global funding stresses. They are creating the conditions that are causing the external environment to be weak, and then they say they can’t hike because of those same conditions that they have created.”
Obviously this is an impossible quagmire. There’s no way out and the decision is just going to get more difficult with each passing FOMC meeting. It’s made all the more convoluted by the fact that not hiking sends a negative message about the US economy, thus imperiling domestic risk assets but hiking could send EM over the edge ... or maybe not... or who knows.
The wording there is no accident. It's literally that indeterminate.
That’s the problem facing the world's EM central bankers and as you can see from the following, everyone is simply dumbfounded.
Via The New York Times:
After a week of discussions [in Lima], bankers and policy makers agreed that stemming the rush of investments from emerging markets was one of the most important challenges facing the global economy. But there was little agreement on how to actually do that.
On official panels, in closed-room sessions and over drinks in Lima restaurants, market participants struggled to come to grips with the persistent flows of money escaping emerging-market stocks and bonds in search of safer investment shores.
“We have never seen something like this,” said Hung Tran, a senior executive at the Institute of International Finance, a trade group for global banks. Mr. Tran said that he was expecting net outflows from emerging markets to be around $800 billion for this year and next — by far the largest amount since institutions began investing in these markets in the late 1980s.
The fear is that these numbers could increase substantially, especially if China’s currency weakens further. That could result in a rolling series of emerging-market crises.
At the root of the debate has been whether the Federal Reserve’s decision last month to hold interest rates near zero has increased investor confidence in emerging markets or hurt it.
Those on the front lines of the outflows of funds from the emerging markets — central bankers in countries like Brazil, Turkey, Malaysia and Mexico — are beginning to say that the Fed’s decision to hold back has actually made their job more difficult. That is because instead of staying put, or making new investments, investors are rushing out all the faster, spooked that the Fed has larger fears about China and other emerging markets.
“I heard time and again this week from governors of emerging-market central banks that it’s not the hike itself that worries them,” said Jacob A. Frenkel, the chairman of J.P. Morgan Chase International and the former head of Israel’s central bank. “It’s how much and when it occurs.”
“Delaying an increase in rates only increases volatility and uncertainty in emerging markets,” said David Fernandez, a currency and bond specialist at Barclays in Singapore. “Emerging markets will continue to see outflows.”
As indicated above, there's really no telling if these bankers' assessments are correct. That is, it could very well be that when the hike actually comes - even if it's a paltry and largely "symbolic" 25 bps - the resultant "tantrum" (so to speak) will be far worse than the what would have occurred if the Fed had just remained on hold and left everyone in suspense. But again, we won't know until it's too late.
Meanwhile, it's important to remember that the fundamentals are awful across EM and at the end of the day, that's the problem. The obsession with the Fed is unhealthy for any number of reasons, but when you've got a commodity space that's in freefall, declining global growth and trade, and acute political crises that include a civil war in one key market (Turkey) and an intractable legislative stalemate in another (Brazil), it's not entirely clear that even if the Fed were to somehow get everything just right going forward that the picture would materially change for the world's emerging economies.