So far, there has been a lot of turbulence in global markets surrounding a few interesting developments. For the past few months, investors have felt that there was a possibility that US stocks were overvalued and as a result switched to safer assets. While the effects have been somewhat worrisome, it is an understandable position considering that several market analysts have felt this way about the market. This might however not be the biggest concern that the US economy may face in the near future.
A few days before the FOMC announced their intention to cut an additional $10 billion from its asset purchasing program, the Turkish and South African central banks aggressively raised short-term interest rates. On January 28th, Turkey raised their one-week lending rate from 4.5% (pretty reasonable for an emerging market) to a staggering 10% overnight. While this was a very strong move by the Turkish central bank, it is certainly not the first to occur in a developing economy. The article also references how India raised their interest rates unexpectedly, albeit the rate increase was not as drastic.
The key question to ask is why is all of this happening, and more importantly why is it happening now? The current pattern for emerging markets is that while they all experienced very high rates of growth, continuing despite the worldwide financial crisis, they have also had high levels of inflation. Inflation though was not considered problematic until 2012. To use Turkey as an example, growth was an impressive 8.9% in 2011 but that dropped sharply in 2012 to 2.2%. A similar situation has occurred in Brazil where growth slowed down dramatically but inflation continued to persist and as a result their central bank raised rates to 9%. High inflation and slow growth was commonly associated with most of the Western World back in the 1970s as industrial sectors slowed down and the current situation in emerging markets looks to be taking that shape. In fact Euromoney and the Royal Bank of Scotland believe that Brazil risks falling into stagflation given their current economic symptoms of slow growth, high inflation, and resulting high interest rates threatening to derail a system that was geared towards enhancing consumer growth. They surmise that there needs to be more of a push towards investment as opposed to consumption. The same can be said of several emerging markets who are struggling, including Turkey, South Africa, and India. The only real cure to stagflation is a pretty bad trade-off between maintaining growth or curbing inflation at growth’s expense.
So how does the Fed come into this? Analysts believe that the Fed took an “Emerging Markets be damned” stance as they decided to cut an additional $10 billion from their asset purchases; however, the Fed cannot really be blamed for the slowdown and high inflation. Their job isn’t to respond solely to market chatter or global turmoil. Unless it immediately falls into the context of the dual mandate, the Fed would not have considered these effects. Besides, the only apparent link between the Fed’s recent monetary policy decisions and emerging markets was when QE3 was in full-effect. In that case, emerging markets would have seen their export sectors suffer a little; however, as indicated above, the problems in emerging markets are of much greater concern than exporting based on an exchange rate. Inflation appears to be here to stay in emerging markets and how they deal with it is out of the Fed’s control.