How Does the Fed’s Recent Action Compare to EM Central Banks?

In an interview on Bloomberg Radio with Tom Keene and Ken Prewitt, I shared my thoughts on the Fed’s recent announcement that it would continue its QE efforts for the time being. If you missed the segment, I’ve summarized that conversation here for you. (Note that this is not an official transcript of our conversation).

Q. At what point do all the central banks begin to react to market turmoil – whether it’s lower bond prices, higher yields or some of the carnage we’ve seen in emerging markets?

A. I think we’re starting to see that already. There’s little doubt that the Fed’s recent action was very hawkish. What I thought was most notable is that the Fed’s criteria for tapering have changed. In Bernanke’s press conference, he indicated that the Federal Open Market Committee (FOMC) should conclude the asset purchase program when the unemployment rate hits seven percent, and then start tapering later in the year. I think that’s a significant development.

But then, when we compare what the Fed is doing with what the other G4 and G10 central banks have done, it’s clear that the other central banks are not in any position to start tightening policy. I think that is very important when it comes to the future of the dollar.

Meanwhile, emerging market central banks are starting to respond to the carnage that we’ve seen there over the last few weeks, by intervening to support their currencies. We know that a whole host of Asian central banks intervened with several hundred million dollars to prop up their currencies. We know that India, Korea, the Philippines, Indonesia – and Brazil most recently – announced that they’re going to hold auctions to prop up their currencies. So, we’re already seeing central banks a bit unnerved by the developments taking place that were triggered by the Fed.

Q. Much of this activity is happening in markets that could use a boost to their economies to begin with. Is it really all that bad if their currency drops a bit?

A. I don’t think so. If you recall, it was Brazil’s Finance Minister Guido Mantega who coined the now popular term ‘currency wars’ some time ago, and central banks have been intervening to prevent their currencies from appreciating ever since. I think this is only a natural adjustment. After all, the U.S. dollar has been in a bear market for the last eight years, and now you’re finally seeing strong, cyclical support for the currency.

One key macro theme that does concern me for the rest of the year is global growth, particularly emerging markets. I’m less concerned about growth in the U.S. and in other parts of the G10, but for emerging markets, the outlook is a bit concerning—particularly China. I think the markets are having a tough time adjusting to a very different economic model in China, and that’s just begun.

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