Emerging Markets and the Fear of the Fed

Friday, March 27

Mr. Robert Burgess, Chief Economist for Emerging Markets in Europe, the Middle East, and Africa, Deutsche Bank

Deutsche Bank’s chief economist for emerging markets (EMs), Robert Burgess, gave a stimulating talk at the JVI on March 27, 2015 entitled “Emerging Markets and Fear of the Fed.”  Mr. Burgess pointed out that the importance of US monetary policy decisions for how investors appraise EMs is readily apparent every Friday in the eager wait on trading floors for release of the US payroll report – an eagerness unrivalled for any release of EM data. A good report for the US, such as a strong rise in employment, is typically bad news for EMs because it means that a hike in the US federal funds rate may be imminent. Higher US interest rates raise the cost of borrowing for EMs and tend to make EM assets less attractive to global investors.

The Fed, Mr. Burgess said, is now in unprecedented territory because in recent decades interest rates have never been so low and because it has been a very long time (3,192 days as of the day of the lecture) since the last hike. Thus, many investors have forgotten what happened last time, making it difficult to draw parallels and devise possible scenarios to cope with it.

Many investors are concerned that there will be a new wave of EM debt crises if the tightening is pronounced. EM growth has already slowed and in many countries structural reforms have stalled.  In general, macroeconomic conditions are far less favorable than in the previous interest rate cycle of the 2000s. However, Mr. Burgess also thinks that such vulnerabilities should not be overplayed. EMs in general have less debt than advanced countries. They also have high reserve cover and government borrowing is now less dependent on borrowing in foreign currency. One major weakness, however, is that many EM businesses are more highly leveraged, with significant debt denominated in foreign currency. Moreover, in many cases such borrowing is not naturally hedged. Where increases in corporate dollar funding are intermediated through local banks, bank exposure to unhedged foreign debt indirectly raises systemic banking risk. While exchange rate overvaluation is not a problem in most EMs today, current account deficits are still somewhat high. All in all, Deutsche Bank sees the next few years as a period of difficult adjustment for EMs but one that is unlikely to result in systemic crises as happened in previous decades.

A key point Mr. Burgess made is that adjustment efforts should be mainly directed to structural policies. To illustrate, he presented a new heat map chart that makes it possible to gauge relative magnitudes by country and stressed the need to combine the heat map of macro vulnerabilities usually employed by the IMF with such a structural vulnerability heat map.

The audience had many questions. They ranged from reasons for the US to raise interest rates to the likely impact of the decision on oil markets and on growth developments in particular countries. When asked for his own forecast for US interest rates, Mr. Burgess said that his “best bet” would be an average between what markets expect and the path suggested by the minutes of Fed Board Governors meetings, which is that by early 2018 the rate would rise by about 200 basis points.

Luis Catão, Senior Economist, JVI


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