Fed Gifts Emerging Markets a Lifeline at Expense of Euro, Yen

Rates on Hold: What It Means for Emerging Markets
  • Gauge of developing-nation currencies extends winning streak
  • Fed impasse boosts euro and yen, undermines ECB, BOJ Stimulus

Emerging markets have a friend in Janet Yellen.

Policy makers from Asia to Latin America can enjoy a reprieve from a 19 percent slump by their currencies over the past year after the Federal Reserve kept rates near zero on Thursday, stemming outflows from these economies. Their counterparts in Europe and Japan aren’t so fortunate; they’re still waiting for a U.S. rate rise that would reduce pressure to bolster easing at home.

Yellen heeded calls from the World Bank and International Monetary Fund to avoid destabilizing global markets with the Fed’s first rate increase in almost a decade. Volatility soared in August across currency, bond and stock markets amid concern slowing growth in China would weigh on the global economy, elevating the stakes for U.S. monetary policy. Officials are watching developments in China and emerging markets, Yellen said Thursday.

“The World Bank was urging the Fed not to raise rates, and a lot of emerging-market countries at the G-20 were saying don’t raise rates,” said Greg Anderson, the global head of foreign-exchange strategy at the Bank of Montreal. “But for the European Central Bank and the Bank of Japan, their currencies strengthen when there’s volatility and they want weak currencies. The best way for them to achieve weak currencies is for the Fed to hike.”

Emerging Problems

Upheaval surrounding any rise in U.S. borrowing costs could lead to a “sizable drop” in capital flowing into developing nations, creating formidable challenges for policy makers, the World Bank warned this week.

The Fed seems to have taken that on board, with Yellen noting that money has already left these countries and saying officials are scrutinizing risks stemming from China and other emerging markets for signs they will affect the U.S. The word “China” or “Chinese” was mentioned 11 times in the Fed’s Beige Book released this month, with the Boston, San Francisco and Dallas districts citing the Asian nation’s slowdown as weakening demand for products including chemicals and high-tech goods.

A gauge of emerging-market currencies rose 0.1 percent on Friday. The measure extended its longest rally since April 2014 after touching the lowest in more than a decade earlier this month.

“For emerging-market central bankers, the Fed has given them some much-needed breathing room,” Jonathan Lewis, a principal at New York-based Samson Capital Advisors, said Thursday. The firm oversees $7.4 billion. “Postponing a Fed tightening gives these central bankers room to be more accommodative, without their actions being offset by a tighter Fed.”

Conversely, ECB President Mario Draghi and BOJ Governor Haruhiko Kuroda face an uphill struggle to renew weakness in the euro and the yen. After slumping in the first half of the year, the two currencies have acted as safe havens amid the China and Fed uncertainty, strengthening more than any of their 10 developed-nation peers over the last three months, Bloomberg Correlation-Weighted Indexes show.

Stronger Yen

The era of a weaker yen is coming to an end and the currency may strengthen toward 115 per dollar, Eisuke Sakakibara, who was nicknamed “Mr Yen” when he served as Japan’s vice-minister of finance, said in an interview in Tokyo Friday.

The euro advanced 1.3 percent to $1.1435 Thursday, while the yen rose 0.5 percent to 120.01 per greenback. The Bloomberg Dollar Spot Index fell 0.6 percent Thursday, its steepest slide since August, and was little changed Friday. Europe’s shared currency fetched $1.1369 as of 11:26 a.m. New York time Friday, while the yen traded at 119.93.

“I’m not sure the ECB will be happy if the euro uptrend continues,” said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan Chase & Co. in Sydney. “It’s about containing downside risks to the inflation story for them and a stronger euro doesn’t help with that.”

Economists from Goldman Sachs Group Inc. and Citigroup Inc. were among those projecting the BOJ will boost stimulus on Oct. 30 even before the Fed’s decision not to raise U.S. rates.

Kuroda and his board left in place on Tuesday in Tokyo their program to increase Japan’s monetary base at an annual pace of 80 trillion yen ($668 billion). The governor repeatedly told reporters that policy makers see a gradual recovery continuing in the economy, while also saying the central bank wouldn’t hesitate to ease if there was some danger of prices not rising to its 2 percent target.

“Money is going out of the U.S. dollar because the Fed isn’t raising rates, but it will flow into less risky currencies like euro and yen,” said Imre Speizer, a senior market strategist at Westpac Banking Corp. in Auckland. “Central banks like the ECB and Bank of Japan will be waiting for the smoke to clear and see what currency trends emerge over the weeks ahead as to implications for their own policies.”

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