Why Emerging Market Fears are Overblown
February 18, 2014
Simon Derrick is a managing director of BNY Mellon and is head of its markets strategy team. Simon established the team more than 10 years ago and developed it into a preeminent center of excellence within BNY Mellon (NYSE:BNY). His views on currency policy matters and on developments within the euro zone are frequently quoted in the financial media.
I spoke with Simon on February 14.
You’ve said that easy money policies in developed markets – the U.S., Europe, Japan and the U.K. – led to capital flows into emerging markets, a process that is now reversing. Was the Fed’s tapering the trigger to that reversal, and can you elaborate on how you see that reversal unfolding?
It’s always hard to make the explicit connections. However, one of the things that is very apparent is that we have run easy-money policies since 2002. One of the simplest ways of measuring that is to look at the average Fed-funds rate versus average headline-inflation rate. It is clear that since the institution of those policies there have been substantial flows into emerging markets. One measure is to have a look at the increase in foreign-exchange reserves in the emerging markets, which have gone from $800 billion at the start of 2002 to something like $7.75 trillion at the end of the third quarter of last year.
Fed tapering will lead to a slowdown of flows into emerging markets. At the start of this year, the World Bank estimated that since 2009, approximately 60% of the inflows into emerging markets had been driven by international factors. It very pointedly included the story of U.S. interest rates as a catalyst. If I look at flows in recent times, since the introduction of QE, you can see that when an additional program came along, more often than not, is when you see an increase in foreign-exchange reserves.
If we are moving towards tapering, then that will have a fairly direct impact on sentiment in certain emerging markets. Bernanke started talking about asset bubbles on May 10 of last year, and then in his testimony to Congress, which was on May 22 of last year, and that was when the discussion of tapering began. That was almost exactly the point problems started in a number of emerging-market nations, and that continued through July and August.
On July 1 of last year, Stanley Fischer gave an interview to the Financial Times. He said, “Look, we expected pressures to emerging markets in the aftermath of what we did. We aren’t particularly surprised.”
Looking at this year, the fresh pressures that formed in the emerging world began at the end of December, almost exactly at the point the Fed was getting ready to start tapering its purchases. Now, that may well have been a knee-jerk reaction rather than a direct impact of the slowdown of growth in the money supply, but nevertheless that was when the pressures in emerging markets started.
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