AS WE FIND ourselves barely two months away from the end of five years of US quantitative easing, if the June minutes from the Federal Reserve’s policy committee are anything to go by, and stare at the prospect of a US interest rate rise in early 2015, it’s worth noting that every sustained period of Fed tightening over the past 30 years has ushered in an emerging-markets crisis.
These crises have been preceded by easy-money boom times in the emerging markets, with heavy international inflows into EM precipitated by the low real US interest rates that prevailed in the late 1970s, early 1990s and early in the last decade. But these ended in mass capital flight – when Fed chairman Paul Volcker tightened rates in the early 1980s, ushering in the so-called “international debt crisis”, and the 1994 Fed tightening that caused the Mexico peso crisis.
Asia-based bankers I spoke to last week on the subject of the risks of Fed policy normalisation provoking another EM crisis, and specifically one in Asia, were sanguine on the topic. The consensus message was: “it’s different this time”. The region has accumulated vast quantities of foreign exchange reserves and its banks are sufficiently well capitalised to act as deterrents to any attempts to force currency meltdowns.
Two countries in the region, India and Indonesia, count among the less-than-enthusiastic members of the club known as the “fragile five” – countries which run uncomfortably high current account deficits (the other EM members are Brazil, South Africa and Turkey) and have suffered speculative routs on their currencies in the past 18 months or so.
I reckon Asia’s DCM bankers have got the right view and that it is indeed different this time
BUT THEY ARE the exception rather than the rule, and even though household leverage has been on an upswing in Asia over the past five years, thanks to booming regional property markets, it’s generally seen as manageable in relation to household income. Corporate balance sheets are less flush with cash in the region, but Asian companies are not yet experiencing the strain of systemic debt service pressures.
They are, of course, issuing oodles of debt, which is snapped up with nary a second thought by real money in Asia, Europe and the US, and the region’s DCM bankers who arrange this debt are sitting as smugly as they ever have. EM has shrugged off the “Taper Terror” of May last year and the mini February rout with an elegance that ignored the doomsday scenarios put out by all the Cassandras.
But the Cassandras are not just looking at the correlation between Fed tightening and EM crises. They are looking at the grand experiment that is QE and suggesting that, just as the bankers would have us believe that it’s different this time for all the right reasons, it’s actually different this time for all the wrong reasons. Sitting squarely in the Cassandra camp are the economists at the Bank for International Settlements, who reckon EM is more vulnerable to interest rate tightening than it was during the Asian financial crisis of the late 1990s.
“The deeper integration of emerging-market economies into global debt markets has made emerging-market bond markets much more sensitive to bond market developments in the advanced economies. The global long-term interest rate now matters much more for the monetary policy choice facing emerging-market economies than a decade ago,” wrote BIS economists in a working paper published in the middle of the February wobble.
The Basel-based institution cited the explosion of debt issuance in EM and the impact of rising long-term US interest rates as “feedback risk” from borrowing costs in the West. EM central banks would face systemic financial instability if the debt issuance which has kept EM economies ticking over since the financial crisis were suddenly to fall off a cliff.
THESE ARE PLAUSIBLE arguments, but they depend on making the prediction that long-term US interest rates will rise. They haven’t done so and show no immediate or medium-term prospect of doing so either.
The risk of QE, so the Cassandras had it, was that it would unleash inflationary pressure in the US economy and push up US Treasury yields, causing mayhem along the way for the borrowers who had binged on debt in the face of the artificially low rates on offer courtesy of QE. It hasn’t happened and I don’t reckon it will, all things being equal – principally I’m thinking an oil supply shock is likely to be the only wild card that would cause an inflationary spike, as it did back in the 1970s.
I reckon Asia’s DCM bankers have got the right view and that it is indeed different this time. Unless Yellen goes inflation-paranoid and puts her foot too hard on the rates gas pedal, Asia’s primary debt markets can be safely expected to enjoy another bumper year in 2015.
As far as the emerging markets are concerned, this Fed tightening cycle will have a very different complexion from those of the past three decades.
