By Ron Rimkus, CFA
As the US Federal Reserve continues with its taper plans, it is clear the status quo is radically shifting - and not just in the United States. Because the monetary system is global, the status quo is shifting around the world. Upon announcing the possible taper in May of 2013, yield curves around the globe began a dramatic shift. The US 10-year Treasury bond yield has climbed from 2.6% or so before the taper announcement to about 3.0% since the taper actually began in December.
Perhaps the bigger story is that capital flows promptly reversed course. During the five years after the global financial crisis of 2008, capital flowed into emerging market countries that were benefiting from the massive influx of liquidity. Countries like Brazil, Russia, India, Indonesia, Malaysia, Singapore and Turkey enjoyed a surge of capital inflows.
However, now, the taper is causing a regime change in the monetary system. Countries like India and Malaysia first experienced runs on their currencies last summer and fall in anticipation of the taper. Given their large current account deficits, it appeared that both countries would be prime targets for investors to exit in the face of imminent policy change. Then, in October 2013, Fed Governor Ben Bernanke announced the so-called "untaper," which put the markets in a state of stasis - and the runs on Indian rupee and Malaysian ringgit stalled.
Then, of course, the Fed announced in December of 2013 that the taper was on. Most recently, the Fed announced last Tuesday that the taper will continue in February. So, in total from December to February, the rate of monetary expansion in the US has fallen from $85 billion per month to $65 billion per month (and appears to be slowly headed toward zero).
Since the taper was delayed, apparently India and Malaysia have stabilized. This situation is a bit puzzling because now that the taper is officially on, a number of other countries are experiencing sharp outflows of capital, such as Turkey, Argentina and Venezuela. Just in the last few days:
- Yields on Argentina's 3-year bonds has spiked from 11% to 19%
- Turkey hiked its policy rate from 7.75% to 12.0%.
- South Africa raised benchmark rates from 5% to 5.5% to stabilize the rand.
- After devaluation of 50% or so last year, Venezuela announced a fresh devaluation of another 44%.
- Lastly, the ruble has now hit an all time low of 40.9 against a basket of currencies, with the central bank indicating it is comfortable with further ruble weakness.
While the magnitude of the impact of this regime change remains unknown, it is all too clear that the shift in US monetary policy is already having profound effects across the globe. It seems that capital is fleeing and interest rates are rising most sharply throughout the Emerging Markets. According to EPFR Global, emerging market equity fund outflows rose to $12.1 billion in the month of January. Emerging market bond funds lost about $2.7 billion last week alone. The outcome of this capital flight from emerging markets is either greater inflation or recession in many emerging market countries, perhaps both.
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