The Fed Has Freed Emerging Markets From Uncertainty
Emerging market officials are listening to the Federal Reserve very carefully -- but they are no longer imitating its every move.
This discretion is a healthy change. It means policy makers in, say, Asia or Latin America can respond to local needs without fear of punishment by investors. It also frees Chair Janet Yellen, or whoever succeeds her, to make calls more on the basis of U.S. conditions without worrying overly about ricocheting in Jakarta, Brasilia or Mumbai. That concern won't go away, but it's probably diminished.
In the past, it wasn't unusual for central banks around the world -- not just in emerging markets -- to broadly replicate the Fed's interest rate moves both up and down. Was there room for local nuance? Sure, but generally a step in the U.S. was sooner or later to be matched.
It was especially the case in emerging markets, partly because the U.S. was the indisputable economic superpower whose business cycles were often harbingers for everywhere else. Currencies had hard or soft pegs to the dollar, and countries simply had to raise domestic borrowing costs to prevent the gap with America widening too much and capital flight following.
This time around there is no lockstep. To the contrary, three of the biggest emerging markets have cut rates as the U.S. has gradually raised them. Borrowing costs have come down in Brazil, Indonesia and India, reflecting the need to give local economies a boost and, for the most part, relatively contained inflation. All the more striking is they have done so without en-masse capital flight. All three currencies are up against the dollar this year.
It's tempting to see this as a result of relative U.S. decline, the rise of China and the emergence of a multi-polar world. And there might be a bit of that. The real cause may be closer to home: the Fed itself.
The Fed is simply much more transparent than it used to be. Does the temple still keep secrets? You bet. But it puts so much more effort now into publishing forecasts and projections and communicating to the public where it is trying to go and how it proposes to get there. It's become quite predictable, relative to most of its 104-year history.
This year, certainly, it is on course to do what it said it would do: raise interest rates three times (two so far, one penciled in for December) and start reducing the bond holdings that swelled its balance sheet. It stuck to that message last month and also left intact its call for three rate hikes next year.
When the Fed is predictable, everyone else can be much less reactive. By reducing financial-market volatility, the Fed has made it easier for the other central banks to plan ahead.
None of this is to say that the Federal Reserve is no longer the world's pre-eminent single economic institution or that the U.S. is growing irrelevant. Rather, it's another illustration of Fed's significance. The Fed remains influential; what has changed is that it has become predictable. This frees other central banks to respond to local needs.
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