There have been many tantrums when it comes to the Federal Reserve’s actions, and speculation is mounting whether there will be more in store when the United States ends its asset-buying programme.
In order to pump money into a pandemic-bruised economy, the US central bank has been buying US$80bn of Treasuries and US$40bn’s worth of mortgage-backed securities every month since July 2021. Such support could soon come to an end, and there are fears of the impact on emerging markets, particularly if the Fed has to move quicker than expected.
It is expected the central bank will phase out the programme towards the end of the year, which could then be followed by rate hikes. Such tapering, however, could have severe implications. Observers point to the ‘taper tantrum’ of 2013 when markets had a kneejerk reaction to the comments of Ben Bernanke, who was Chair of the Federal Reserve at the time. The tapering of the programme – which was introduced in the wake of the global financial crisis – hadn’t started; it was merely a reaction to Bernanke’s comments of what could happen. Treasury yields dramatically increased, and in emerging markets it triggered interest rate hikes and capital flight.
In a session on emerging market capital flows organised by the Official Monetary and Financial Institutions Forum (OMFIF), Otaviano Canuto, non-resident senior fellow, Brookings Institute, debated the likelihood of another taper tantrum with other experts.
There has already been something of a mini tantrum earlier this year, in February and March, when there was anticipation that the Fed would begin tapering its current programme. Canuto noted that since then markets have been kept cool as the Fed has promised to give more advance warning before it actually starts tapering its bond-buying programme. However, “uncertainty remains for emerging markets,” says Canuto.
Canuto pointed to the differences with the previous tantrum. In 2013, he explained, the ‘fragile five’ – South Africa, Brazil, India, Indonesia and Turkey – had current account deficits and depended heavily on inflows of foreign capital. These days, explains Canuto, the current account deficits are much smaller. Now they are approximately 0.4% of GDP, whereas before it was more like 4.4% of GDP.
Added to this, many emerging markets have maintained reserve ratios that are much higher than the 2013 levels and they meet the level prescribed by the International Monetary Fund (IMF), says Canuto. Also, unlike 2013 when Bernanke’s words unleashed a wave of panic, the Fed is more likely to be offering “appropriate” signalling this time around.
Speaking in the same OMFIF session, David Lubin, Managing Director and Head of Emerging Markets Economics, Citi, commented on the explanations of previous tantrums. He said that with the 2013 sell off, and another in May 2018 [when the Fed reduced its assets], “The conventional way of explaining these run-offs is just to refer to changes in the structure of US monetary conditions,” he says. But to really understand the sell-offs, he adds, China needs to be brought into the analysis.
With the previous tantrum, Lubin noted that China was in the process of withdrawing credit stimulus from its domestic economy. This in turn caused a big negative shock to the investment cycle in emerging markets. “China has been the global weather-maker in the investment cycle,” Lubin said, and this withdrawal of credit stimulus had an impact on emerging markets.
Although there are some elements in the current situation that are similar to the tantrums of 2013 and 2018, Lubin agreed with Canuto that the external financing requirements for emerging markets this time around are very small when compared to 2013. “There is very limited need for external financing – that makes them more resilient,” Lubin says.
Although the likelihood of a taper tantrum was minimised, Canuto said, “The risks for emerging markets lie elsewhere.” For example, emerging markets have had a relatively-slow take-up of Covid vaccinations and they are facing the inflationary impact of commodity price hikes, he said.