Monetary policies in some countries experience a deep change after some years of relax due to the financial and economic crisis. US Federal Reserve is the machine in this movement. The announcement in December that the central bank reduced its debt purchases (broadly known as Quantitative Easing), originally focused to avoid deflation and promote an economic improvement, provoked an earthquake in the emerging markets. Why? Well, there were already signs in August, but these countries are now less attractive as the US bond rate outlook tends to increase.
Emerging markets benefit these years from capital flows from developed countries. Low interest rates and economic crisis in US, Europe and Japan put them in the investors’ focus. But the QE tapering continued in last week’s Federal Reserve meeting activated the alarms. The IMF alerted about a possible turmoil in developing countries, but it was too late: India, Brazil, South Africa and Turkey increased their interest rates to protect their currencies and keep the attractiveness for investors. In the particular case of Turkey, the central bank doubled the rates. However, volatility exploded and bears dominated markets. The following chart, extracted from T-Advisor, showed the five worst markets last week:
But the effects multiplied and affected the whole world, as we can see in this chart from T-Advisor:
Possibly, the 1997-98 crisis will not repeat, as emerging markets have other strengths, but instability will be the next months’ market behaviour.
US Federal Reserve will tend surely to continue its tapering in a slow pace, but markets take into account that this year will be the last one with quantitative easing. Dollar will tend to be stronger and US bond will tend to increase. At the other side of the Atlantic Ocean, the ECB will tend to keep a flexible monetary policy, as Mr. Draghi observes some deflation risks. The open question is if the European Central Bank will act surprisingly as it did in November with an unexpected rate cut.
These changes in the world capital flows will have a deep impact in emerging markets. Investors should look for the best information to react immediately and avoid possible losses in their portfolios.