By Anthony Harrington
Perhaps the most astonishing thing about the latest Federal Open Markets Committee (FOMC) meeting statement on 29 January 2014 was the blithe and merry way in which the Fed opted to completely ignore the crisis that the expectation of its latest round of tapering had already provoked in emerging markets (EM). As reported by Business Insider, several Wall Street analysts jumped on this fact. Stephen Englander, Global Head of G-10 FX Strategy at Citi commented:
"From the viewpoint of domestic US economic conditions, the statement is completely anodyne. From the point of view of EM, the Fed has just said 'hasta la vista, baby'."
Chris Low, Chief Economist at FTN Financial makes a similar comment but broadens it out to point out that the FOMC statement also ignores the fact that the stock markets have been knocked back sharply by their fears over tapering:
"Stocks are falling after the Fed statement, likely because the market unrest gripping traders the past several days seems to have escaped the Fed's notice. We expect this apparent oversight will be addressed verbally when the post-meeting gag period ends and in writing when the minutes are revealed. Still, in the past three trading days, U.S. equities are down 3%, some emerging market currencies are off double digits and foreign central banks are fighting for their financial lives. The fact that it doesn't warrant even a passing mention in the Fed statement shows where all this falls on the Fed’s list of priorities."
In some ways, the Fed's silence on EM should not have been surprising since it is absolutely true to form. In an earlier blog, I pointed out that when the EM currency crisis began in May 2013, prompted by the Fed's first announcement that it was contemplating tapering off its quantitative easing (QE) program, the Fed had made it plain in a number of ways that its focus was US growth, not EM currency issues. EM central bankers who tried to lobby the Fed about their fears over tapering were politely referred to the International Monetary Fund (IMF) as the proper forum for resolving any distress they might be feeling! In that blog, I suggested that while this was understandable, since otherwise the Fed would end up widening its remit to the point where it was making monetary policy for the world, this was a somewhat myopic view. As many commentators have pointed out, the direction taken by US economic and monetary policy has a major impact on the global economy, and choices which bring short term gains for the US at the expense of growth in the wider global economy inevitably return to bite the US rather forcefully in the rear.
Because EMs already account for 50% of the world's economy, plunging them into crisis is something one would expect an enlightened administration to care about. Bernanke and his colleagues on the FOMC are not stupid people, so one is left scratching one's head wondering why the FOMC did not at least mention the likely impact of tapering on EMs. One explanation is provided by Adrian Miller, Director of Fixed Income Strategy at GMP Securities, who suggests that the Fed refrained from mentioning the EM turmoil because it did not want to add fuel to the crisis by highlighting it.
A more likely reason is that given by Business Insider's Matthew Boesler, who points out that FOMC statements are agreed two weeks in advance and are difficult to tweak at the last moment to take account of breaking news. Argentina triggered this current wave of EM currency crises when its central bank faced up to the fact that it was running out of firepower to keep defending the Argentinean peso and decided to let it float - or sink - as the markets determined. In two days, from 22-23 January, the peso lost 15% of its value against the dollar, moving from 6.9 pesos to the dollar to 8 pesos. The sudden drop in the peso sent ripples through emerging market currencies as investors took the fall of the peso as a sign to dump EM stocks and currencies. The "fragile five", Brazil, Argentina, Russia, Turkey and South Africa, all saw significant falls in their currencies against the dollar. As central banks in emerging markets move to shore up their currencies by putting up interest rates, thus tightening monetary policy, investors start to anticipate slowing growth in EMs and their attention shifts to developed markets (DMs) which are suddenly looking a lot better than they have done for the last five years.
The point is that all this happened rather late in the day for the FOMC to write the EM currency crisis into its script. Doubtless, it could have, if it really wanted to, but it would have been difficult. It will be interesting from here on in to see how long the Fed can ignore the EM crisis and whether the Fed lets the prospect of an EM meltdown counter its decision to keep on tapering. Most commentators seem to think that the Fed is going to ignore EMs for as long as it can.