The Fed won’t save emerging markets
Turkey, Argentina and South Africa are in serious trouble, causing stocks to tumble
When emerging markets run into trouble, the trouble can keep getting worse until the Federal Reserve rides to the rescue. But what if the Fed never shows up?
The decision by Turkey’s central bank on Thursday to sharply raise interest rates was just the latest sign of how unsettled emerging markets have become. Facing a deep slide in the lira and a steep run higher in inflation, the central bank felt compelled to lift rates to restore investor confidence—a risky gambit that boosted the lira but could further damage the economy while inviting President Recep Tayyip Erdogan’s ire.
It isn’t just Turkey: Argentina and South Africa also are in serious trouble. An inflation problem is just one of the issues Mexico’s incoming populist president will face. Indonesia has an inflation problem and lots of foreign debt. And while it is possible to view each country’s woes as idiosyncratic, investors aren’t seeing it that way. Last week, emerging-market stocks tumbled into bear-market territory.
Part of the challenge for emerging markets comes down to what the Fed is doing, and here the problem takes on a familiar hue.
The Fed has been raising rates and, with the economy growing strongly and unemployment low, it seems likely to keep on raising them. That in itself wouldn’t be a problem for emerging-market countries if their economies were powering ahead. But in many cases growth is slowing, which, combined with higher funding costs, makes for a dangerous mix.
The emerging-market troubles in early 2016 shared a similar dynamic. The Fed had raised rates for the first time since the crisis in December 2015, and signaled an intention to keep raising them. But the convulsions in emerging markets made the Fed worried about the U.S. economy and it delayed further rate increases. That is similar to what happened in the late 1990s when the Fed raised rates, helping to set off a series of emergingmarkets crises culminating with the 1998 Russian debt default. The Fed ended up cutting rates in response.
But the Fed might not be deterred this time. The central bank isn’t nearly as worried about the U.S. economy as it was in early 2016. U.S. financial markets are less vulnerable to an emerging-markets crisis today than they were in the 1990s.
There are factors that could mute the impact of the Fed’s rate increases on emerging markets.
The U.S. and other developed economies are doing well, so expanded exports might provide some emerging-market countries with a boost. China is adding fiscal stimulus, which also should help. But the risk is that those positives won’t do enough to offset the Fed, and bad as things for many emerging markets are now, they only get worse.