In the meantime, let’s stop blaming the Fed for the problems now faced by emerging markets, says Cornelissen. Most leaders of emerging economies did not complain when money started flooding into their countries when quantitative easing began three years ago – and now that the good times are over, capital flight is only to be expected, he says. It also is not the principle reason behind their recent difficulties.
“The current problems in selected emerging markets cannot be primarily attributed to the tapering decisions of the Fed,” says Cornelissen. “The policy mix in emerging markets has been too loose, as suggested by factors such as the current account deficit of Turkey rising to more than 7% of GDP.”
“The phrase ‘fragile five’ was coined to highlight the vulnerability of Brazil, India, Indonesia, South Africa and Turkey due to their current account deficits. The policy mix has to change, though it would be a bad idea trying to stabilize exchange rates vis-à-vis the US dollar by hiking interest rates prohibitively high.”
JP Morgan Emerging Market Currency Index (% YOY)
Source: JP Morgan
Weaker growth won’t derail West
“The weakening of emerging market currencies will contribute to a rebalancing of their economies and a lowering of current account deficits. Weaker growth in selected emerging markets will therefore be unable to derail the ongoing recovery in developed markets. Their economic clout is too small. It could of course contribute to a weakening of commodity prices, which ironically would actually further strengthen the recovery in advanced economies.”
Critics accusing the Fed of adopting a parochial policy have noted that recent statements don’t refer to the turmoil in emerging markets, unlike more tactful policy statements by the European Central Bank.
‘The economic clout of emerging markets is too small’
“The Fed is well aware of the external impact of its policies, but in the highly polarized political atmosphere in Washington, it prefers to communicate within the limits of its mandate,” Cornelissen says. Indeed, critics within the US had previously accused the Fed of not being nationalistic enough.
He says the Fed won’t back down from its tapering program because the current strength of the US economy is probably underestimated. Fourth-quarter GDP growth was once again a positive surprise, as was the third-quarter figure. The US government won’t be a drag on growth as in 2013 due to severe sequestration, where it is legally obliged to cut the deficit by reduced spending. And the non-manufacturing PMI rose in January to 54.0 from 53.0 (a figure above 50 indicates growth), suggesting further strengthening.