Over the weekend, when commenting on the ongoing rout in emerging markets, Bloomberg published an article titled "Rattled Emerging Markets Say: It's Over to You, Central Bankers." Well, overnight the most important central banker of all, Fed Chair Jay Powell responded to these pleas to "do something", and it wasn't what EMs - or those used to being bailed out by the Fed - wanted to hear.
As Powell explained, speaking at a conference sponsored by the IMF and Swiss National Bank in Zurich, the Fed's gradual push towards higher interest rates shouldn’t be blamed for any roiling of emerging market economies - which are well placed to navigate the tightening of U.S. monetary policy. In other words, with the Fed's monetary policy painfully transparent, Powell's message to EM's was simple: "you're on your own."
Arguing that the Fed's decision-making isn’t the major determinant of flows of capital into developing economies (which, of course, it is especially as the Fed gradually reverses the biggest monetary experiment in history) Powell said the influence of the Fed on global financial conditions should not be overstated, despite Bernanke taking the blame five years ago for the so-called taper tantrum.
"There is good reason to think that the normalization of monetary policy in advanced economies should continue to prove manageable for EMEs,” Powell said, adding that “markets should not be surprised by our actions if the economy evolves in line with expectations.”
Powell added that the Fed can help "foster continued financial stability" as policy normalization continues by communicating "our policy strategy as clearly and transparently as possible to help align expectations and avoid market disruptions."
Alas, that's not what markets cared about, or wanted to hear, and instead Powell's unwillingness to suggest a slowdown in the Fed's tightening plans, EMs be damned, were enough to propel the dollar to new highs...
... in the process again slamming the EM complex, which as shown below has been a bloodbath over the past month - as dollar has soared against most developing-nation currencies - and explains the escalating rout among emerging markets.
As discussed previously, the FX rout has also spread to EM bond markets as debt sales from countries such as Russia and Argentina have been canceled or postponed recently as potential buyers have balked at the prospect of faster inflation and widening budget deficits.
Meanwhile, as the Fed refuses to change course, other policy makers have been forced to step in to counter the sharp, sudden capital outflows, with Argentina’s central bank abruptly raising rates three times, to 40% to halt a sell-off in the peso.
Russia has also put the brakes on further monetary easing. Turkey, which is a unique basket case in that Erdogan is expressly prohibiting the central bank from doing the one thing it should to ease the ongoing panic, i.e., raise rates, is seeking to bring down its current account deficit. Overnight, we learned that Indonesia was burning reserves to prop up its currency.
Meanwhile, also overnight, JPM CEO Jamie Dimon said it’s possible U.S. growth and inflation prove fast enough to prompt the Fed to raise interest rates more than many anticipate, and it would be wise to prepare for benchmark yields to climb to 4%. Such a scenario would be a disaster for EMs:
A sustained move higher would pressure local currencies and lure away foreign investors. The International Monetary Fund warned last month that risks to global financial stability have increased over the past six months.
“Central banks may have to respond with interest rate hikes if the sell-off intensifies,” said Chua Hak Bin, a senior economist at Maybank Kim Eng Research in Singapore. Those most vulnerable include Ukraine, China, Argentina, South Africa and Turkey according to the Institute for International Finance.
Needless to say, hiking rates just as the global economy is starting to slide is just the catalyst needed for a global recession.
Meanwhile, there are capital markets to think of: if and when the contagion begins, and the selling spills over from EMs to development markets, the Fed will have no choice but to step in, something Powell himself hinted at:
I do not dismiss the prospective risks emanating from global policy normalization. Some investors and institutions may not be well positioned for a rise in interest rates, even one that markets broadly anticipate. And, of course, future economic conditions may surprise us, as they often do.
He was referring to the following divergence between hedge fund and "Real Money" positioning on EMs, where as JPM noted over the weekend, the "smart money" is well ahead of the curve.
As for the indicator that markets should keep an eye on to decide when it's time to panic, we reported yesterday that Bank of America is keeping an eye on one specific catalyst for imminent contagion: "EM FX never lies and a plunge in Brazilian real toward 4 versus US dollar is likely to cause deleveraging and contagion across credit portfolios."