Fed makes world safe for emerging markets

Jerome Powell is surely tired of taking hits from Donald Trump’s White House. Never before has a Federal Reserve chairman been called “crazy” and “out of control” by a US president.

If Powell is craving some love, he might find it here in Asia – especially in this region’s emerging economies. 

That is the upshot of a new report from the Institute of International Finance. Titled “Fed kicks off spike in flows to EMs,” it is a generalized look at how a “wall of money” is beginning to rediscover economies from Mexico to South Africa to Indonesia. These are among the places hit hardest by the mini-panic in global markets in late 2018. 

The Fed’s four rate hikes last year weren’t the cause. That dubious honor is largely Trump’s. His tariffs took a wrecking ball to Chinese trade flows, driving mainland growth to the lowest level since 1990. But Powell’s shift to a wait-and-see mode is already breathing new life into markets from Jakarta to Seoul to Beijing.

Given Asia’s rapid growth and swelling consumer sectors, the region is a clear standout. That doesn’t mean emerging Asia is out of the proverbial woods. In fact, the respite Powell’s team is affording the region is a window to raise economic games. 

The reason currencies from Mumbai to Jakarta to Manila cratered in 2018 is twin deficits in budgets and current accounts. If policymakers had done more to tighten balance sheets in the rapid-growth years following the 2008 global crisis, their economies would’ve been less vulnerable to Trump’s tariffs. 

Had emerging Asia done more since its 1997 crisis to wean economies off exports, the region might have more reliable shock absorbers. Had leaders deregulated industry more assertively, economies might be more competitive and nimbler. Had they been more confident about leaving the private sector alone, Asia might be churning out even more startup unicorns. 

Even so, the Fed’s rate-hike pause means “the hunt for yield is clearly underway again, and no longer confined to China, but broadening out to the rest of EM, including Mexico, South Korea, Indonesia and – more recently – Turkey,” writes an IIF team led by chief economist Robin Brooks. 

India also is winning back capital. For now, at least. Questions abound about what the Reserve Bank of India was thinking on February 6 when it cut interest rates. Those who think they know – supporting the government ahead a May election – are already crying foul. 

Shaktikanta Das, the RBI’s new governor, looked a bit too accommodating in his first rate decision. In December, Urjit Patel abruptly quit the job, the second governor to vacate the office in just over three years amid fears of government meddling.

And now Das shocks Mumbai markets with a surprise 25 basis point cut, putting the benchmark rate at 6.25%. Clearly, Prime Minister Narendra Modi is happy ahead of May. Investors, perhaps not so much if the rupee craters anew. 

All bets are off, of course, if Powell decides to resume the Fed’s tightening cycle. At the moment, as former US Treasury Secretary Lawrence Summers told Axios: “Powell seems to be adopting the ‘whites of the eyes of inflation‘ position that I and many others have advocated for a long time.” 

Part of what worries Summers stems from his pivotal role in combating Asia’s 1997 crisis. As the top Treasury official in Bill Clinton’s White House, Summers helped craft the bailout packages that stabilized Indonesia, Thailand and South Korea. And while some of those efforts came under fire years later, Summers recalls all too well the role tight policy played in Asia’s unraveling. 

Yet Trump’s trade shenanigans remain a wild card. News last week that Trump doesn’t plan to meet with China’s Xi Jinping ahead of the March 1 deadline for new tariffs spooked markets anew. At the same time, any move by Trump to weaken the dollar to gain advantage versus Asia could slam markets. 

For emerging Asia, though, the Fed’s pause is the breather needed to regroup and raise economic games. 

All this “emphasizes the dilemma that emerging market investors face in 2019,” says Udith Sikand of Gavekal Research. “Softer relative growth prospects in the US as the initial effects of 2018’s tax cuts wear off, coupled with the easing of the US dollar liquidity squeeze implied by a more dovish Federal Reserve and softer oil price, favor emerging market assets.” 

That augurs well for financial stability in Asia’s emerging markets, bonds and stocks. Ditto for Powell’s self-esteem as Asia appreciated his handiwork in ways Trump doesn’t.

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