Yellen Leads Fed Damned Every Way by Emerging Market Angst
Janet Yellen is discovering that when it comes to providing monetary stimulus, the Federal Reserve is damned by emerging markets when it does and damned when it doesn’t.
Sixteen months after she used a Tokyo gathering of global policy makers to defend her institution against criticism it was purchasing too many assets, Fed Chair Yellen attends this week’s Group of 20 meeting in Sydney being lobbied to pay greater attention to foreign fallout as the U.S. slows its bond-buying.
What’s not changed is her response: A well-managed U.S. economy benefits the world and other central banks have tools to support their own economies. That’s disappointing counterparts such as India’s Raghuram Rajan and Gill Marcus of South Africa, who criticized the lack of a synchronized global monetary policy as developing-nation currencies suffer their worst start to a year since 2010.
The Fed’s “job is not to make policy for India, it’s to make policy for the U.S.,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and a former Fed economist. “Blaming other people for their problems isn’t very helpful.”
Almost three weeks since taking the helm of the Fed, Yellen, 67, makes her international debut as its chief when she joins fellow G-20 finance ministers and central bankers at the Feb. 22-23 talks. They meet in the wake of a decline in emerging-market shares and currencies on concern over softer economic growth.
Blamed in part for the sell-off and need for interest-rate increases from Brazil to India is the Fed’s decision of December to pull back its $85 billion-a-month asset purchase program, which it has since lopped to $65 billion. U.S. monetary policy will be part of the debate in Sydney, G-20 officials say.
The recent volatility doesn’t pose a “substantial risk to the U.S. economic outlook,” Yellen said on Feb. 11, signaling the tapering will continue. The U.S. central bank sets policy “to pursue our goals that Congress has assigned,” she said.
In an accompanying report, the Fed described the rate increases in emerging markets as “stopgap measures” that should be coupled with fiscal and structural changes “to help remedy fundamental vulnerabilities.”
The Fed will react only if the emerging-market woes start “to have a more meaningful impact on monetary conditions and/or growth,” in the U.S, said Dario Perkins, director of global economics at Lombard Street Research Ltd. in London and a former U.K. Treasury official. “In the absence of such weakness, the Fed will continue to taper.”
That may irk some of Yellen’s G-20 counterparts. Reserve Bank of India Governor Rajan told Bloomberg News on Jan. 30 that international monetary cooperation “has broken down.” He said developed countries can’t “wash their hands off and say we’ll do what we need to and you do the adjustment.”
Marcus, who has led South Africa’s central bank since 2009, said in a Feb. 3 interview that it’s in the Fed’s interest to ensure less turbulence in developing nations.
“Statements that we need to more explicitly coordinate international policy are a bit overblown compared to where real gains would be from doing that,” St. Louis Fed President James Bullard told reporters in Washington yesterday.
“So as long as every country pursues its own monetary policy for its own purposes and does a good job at that, you get a pretty good global equilibrium that isn’t too far from the one that you would get if everyone was under the same monetary policy or was perfectly coordinating monetary policy,” he said.
While Fed policy makers didn’t mention emerging markets in their last policy statement, officials agreed the unfolding events in emerging markets “needed to be watched carefully,” minutes of their January meeting released yesterday show.
“Recent volatility in emerging markets appeared to have had only a limited effect to date on U.S. financial markets,” according to the record of the gathering. “It was also noted that recent developments in several emerging market economies, if they continued, could pose downside risks to the outlook.”
Fed policy makers backed away from their year-old commitment to consider raising interest rates when unemployment falls below 6.5 percent. With the jobless rate falling faster than expected even as other labor-market indicators show weakness, policy makers agreed it would “soon be appropriate” to revise their guidance about how long the era of low interest rates will remain, the minutes showed.
Risks of prolonged market turmoil in emerging markets and of deflation in the euro area are threatening the world’s improved economic prospects, according to the International Monetary Fund. In a staff report prepared for central bankers and finance ministers from the G-20, the IMF said the recovery is still weak and “significant downside risks remain.”
For Stephen Cecchetti, a former economic adviser to the Bank for International Settlements, the lesson is that monetary policy cannot be relied upon alone to fix economic weaknesses and governments must do more. That will be a theme of the Sydney meeting too as Australia pushes infrastructure investment as a way to spur jobs.
Other measures might come from trade liberalization, reducing wasteful subsidies, curbs on state-owned companies or simply being more open to foreign investment, said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong.
Goldman Sachs Group Inc. told investors in December that a lack of economic reforms meant they should cut allocations in developing nations by a third, predicting a “significant underperformance” for stocks, bonds and currencies over the next 10 years.
Countries which did take advantage of capital flows to revamp their economies, such as Mexico and South Korea, are now in better shape and show what can be achieved, according to William Rhodes, senior adviser to Citigroup Inc.
“Recent market events should be an incentive to emerging-market countries to put in place structural reforms quickly,” said Rhodes, who is now president and chief executive officer of William R. Rhodes Global Advisors LLC in New York.
Less than two years ago, the Fed’s asset purchases were blamed for encumbering emerging nations with speculative capital and pushing up their currencies, making exports more expensive.
As Fed vice chairman at the time, Yellen’s response was to tell a meeting of the IMF in October 2012 in Tokyo that “on balance, stronger U.S. growth is beneficial for the entire global economy.”
That line was echoed on Jan. 31 this year by Federal Reserve Bank of Dallas President Richard Fisher, who said: “If we’re strong, others will benefit from it.”
European Central Bank President Mario Draghi reinforced the idea that it is up to each institution to keep its house in order. “The priority for all of us is the compliance with our mandate,” he said on Feb. 6 in Frankfurt.
The following week, Australian Treasurer Joe Hockey said the world “can no longer rely on methadone every day” from easy U.S. monetary policy and that central banks must act in their national interests.
Some recent academic research suggests the concerns in developing nations may be overblown. A January study by Kristin Forbes of Massachusetts Institute of Technology’s Sloan School of Management found that for all the complaining, U.S. interest rates had only a 12 percent correlation with private capital flows to emerging markets from 1990 to 2013.
Not all agree the Fed is blameless. John Taylor, a former Undersecretary at the U.S. Treasury and now a professor at Stanford University, said in a July paper that the Fed and other leading central banks should return to the rules-based monetary policy of the 1980s and 1990s, which generated a form of coordination.
Neil Mackinnon, a global macro strategist at VTB Capital Plc in London, wrote in a Feb. 17 note that any deterioration in international monetary cooperation will probably provoke “an increase in protectionism, an increase in capital controls and a retreat into economic isolationism.”
For all sides, the G-20 meeting will allow a clearing of the air, said Pier Carlo Padoan, chief economist at the Organization for Economic Cooperation and Development, who will be in Sydney.
“We need more exchange of information, we need more consideration especially among large central banks about the impacts of what they’re doing,” Padoan said in an interview. “There is one place where that can take place, which is the G-20 meeting.”
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