December 6, 2013
Decision bolsters view that US will drive global growth
The Fed’s decision to hold back on cutting its purchases of US$85 billion a month in bonds may give a temporary respite to developing country economies, which were roiled by the prospect of a reduction. But the easing is inevitable and analysts see more pain ahead for the emerging markets.
The Fed had been widely expected to begin reducing the extraordinary bond purchases that have poured cash into the economy and supported growth at a time when already low interest rates could not be cut much further, limiting the Fed’s range of monetary policy options to spur sluggish growth. But the Central Bank surprised by holding off to ensure that the US economy is stable enough to withstand a pullback.
The ongoing stimulus bodes well for the strength of the US economy but the Fed wants to start unwinding the unconventional stimulus measures and return to normal monetary policy. Central bankers also worry that if they do not begin cutting back, cheap and plentiful money could fuel inflation and bubbles in asset markets like stocks or housing.
Earlier this month, the International Monetary Fund said it saw the dynamics of global growth shifting, with the US expected to drive expansion in the near term helped by European and Japanese economies recovering from their slump. The forecast was a departure from IMF assessments earlier this year that developing economies such as China, India and Brazil would be the drivers of the global economy this year.
Those emerging economies have been rockedof late as anticipation grew for the Fed to begin easing off stimulus. While US interest rates were low and cash was abundant, capital flowed into riskier emerging markets where rates were higher, making investments more lucrative.
The Fed’s warnings since May about the impending pullback in bond-buying caused a big shift in those financial flows, sending some of that money back into the lower-risk US market as interest rates rise again and growth prospects improve.
Some developing countries have seen their currencies and stock prices tumble as a result. In Asia, Indonesia and India have been the hardest hit because of weaknesses in their economies such as high inflation and current account deficits. India’s national currency lost a sixth of its value in recent months and stocks plunged. The IMF has warned there is a risk of a crisis in emerging markets if that turmoil grows.
Win Thin, global head of emerging markets strategy at wealth management firm Brown Brothers Harriman, said there are disagreements within the Fed and enough uncertainty about the direction of monetary policy to keep emerging markets under pressure into next year. He also said he did not think the reversal of capital flows had run its course yet and it would take a while to completely play out.
“The rebalance is not finished yet,” he said. “From now until next year, it’s going to be pretty dicey for emerging markets.”