Insight & action

Emerging Markets and the Fed's New Mantra

The Fed has spoken, and emerging markets don't like the message.

Two regional Federal Reserve Bank presidents utter the same two words on the same day: High Hurdle.

Messrs. Evans and Lacker were addressing their constituents yesterday, offering a unified front on what appears to be a nearly irrevocable path. If indeed the Fed continues tapering its bond purchasing program by $10 billion per month, its balance sheet will finally stop increasing, and will finish the year at a record $4.3 trillion.

The Fed's largesse has done much for global asset prices, providing unprecedented fuel for purchasing everything from sovereign debt to bank stocks. All that is about to end. Call it a return to normalcy as the economy shows signs of growth.

The U.S. may be able to get over its liquidity addition, but emerging markets will struggle if events of the past 24 hours are any indication.

So peripheral countries are feeling the pinch. Even Japan's Nikkei has fallen 7.8 percent in a week. Ouch.

Bottom line: Investors need to stash their money someplace. As long as the Fed stays the dominant player in determining global liquidity, the dollar stays the dominant safe haven. This trend is evident when comparing the Dollar Index (DXY) to the JPMorgan Emerging Currency Index.

We believe the divergence will continue, as do the 23 currency strategists tracked by Bloomberg. The collectively forecast a gain for the dollar of 4.9 percent by year end.

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