MNI INTERVIEW: Emerging Markets Less Sensitive To Fed Moves

Emerging market economies have become more insulated to Federal Reserve interest rate moves than in the past, in part because of constructive reforms in fiscal, monetary and FX policy, Steve Kamin, former head of the Fed Board's Division of International Finance, told MNI. 

"I would identify a number of reasons why emerging markets are less sensitive to Fed policy than in the 'bad old days' of the 1980s and 1990s, such as better EME policies, greater familiarity by global investors so they are less likely to flee at the first sign of trouble, and better and more transparent communication by the Fed, making the moves less of a surprise," Kamin said.  

Kamin is the co-author of a new study showing EM nations have demonstrated much greater resilience to the Fed's sharp rate hikes from 2022 through 2023 than in previous cycles, a resilience that was underpinned by the strength of U.S. corporate credit markets and the associated willingness of investors to continue betting on riskier assets, he said. 

"U.S. corporate credit markets remained buoyant, and their confidence spilled over to EMEs. Second, simply put, Fed tightening is no longer as injurious to EMEs as commonly believed, likely reflecting policy reforms since the 1980s and 1990s," Kamin said. 

The study mentions that the tightening of monetary policy by the Fed has been credited with triggering the Latin American debt crisis of the 1980s as well as the Mexican "Tequila" crisis of 1994-95, for example. Yet the findings suggest that "contrary to conventional wisdom, U.S. monetary policies have been a relatively unimportant driver of EME spreads during the past couple of decades." (See MNI INTERVIEW: Latam Neutral Rates Stable Through Pandemic)

MORE RESILIENT

He stressed these changes have been in train since the early 2000s, not only after the pandemic. "I don't think EMEs are completely out of the woods as regards future shocks, but they are much more resilient than in the 1980s and 1990s."

The swings in market sentiment during the global financial crisis in 2008-09 and the pandemic panic in 2020 had much larger effects on EM spreads than Fed policy, the former Fed economist said.

"Of course, just because it's called 'market sentiment' doesn't mean the market moves are unjustified — during 2008-09 and 2020, there were legitimate fears about a global catastrophe."

Recently, emerging market currencies have been behaving well during the episode of tariffs implemented by U.S. President Donald Trump and the escalation of geopolitical tensions.

"I think there are two reasons why EM currencies have performed well. The first is that US corporate spreads have remained quite contained, despite the turbulence. The second is that global investors seem to have decided to pull away from the dollar, which now behaves more like an EM currency," Kamin said.

ROOM TO IMPROVE 

While many EM economies have bolstered their macroeconomic and financial policies, most still have room to implement more pro-growth structural reforms to improve competition, reduce regulatory barriers, and bolster productivity growth, he said.

"I'm thinking especially about Latin America, where the monetary policy in the five major inflation-targeting countries has been good, but where productivity still lags," Kamin said. He added many economies have run into trouble in recent years and still have a ways to go in this regard, particularly so-called "frontier" markets like Pakistan and Egypt.