Fed Hawk Down; Emerging Markets to Benefit, but Only Short Term

 | Apr 05, 2017 | 9:00 AM EDT
  • Comment
  • Print Print
  • Print

The resignation of Federal Reserve Bank of Richmond President Jeffrey Lacker highlights a phenomenon that the markets probably have not fully priced in: the shooting down, one by one, of the Fed hawks. Emerging markets stand to benefit from this development over the short term. However, it may hinder, rather than help, their progress over the long haul.

OK, perhaps the statement about the "shooting down" of the hawks is an exaggeration, because Lacker resigned over a leak of confidential information to an analyst. But the leak happened in 2012, he has been investigated for it, and he was set to retire anyway in October. Departing now only adds to speculation that there is a lot of pressure from Republicans to gain control over the Fed.

President Donald Trump's view that the Fed is too hawkish and the dollar too strong in relation to world currencies is well-known. Although Fed Chairwoman Janet Yellen has been standing up to him and has insisted the Fed is only taking into account the economy when deciding on interest rates, her mandate expires next year. By the way, she is considered by many in the market to be a dove herself, so if Trump doesn't like her stance, imagine how much more dovish the Fed could become.

Lacker isn't a voting member of the Federal Open Market Committee (FOMC) this year, but he has been an outspoken public speaker in favor of the Fed tightening monetary policy. Also, non-voting Fed presidents still can influence the other Fed officials: They attend meetings of the FOMC, take part in discussions and have their input into the committee's assessment of the economy and policy options.

The Trump administration will have further opportunities to appoint fresh faces to the Fed. Daniel Tarullo, a member of the Board of Governors, is leaving this week. Another two of the seven seats of the board were already vacant. (The president nominates the board members, who must be confirmed by the Senate.)

No wonder, then, that the dollar softened versus the euro in early trading on Wednesday in Europe despite a plethora of political challenges for the European Union, such as the start of what are likely to be difficult Brexit negotiations and the French election.

But it probably will be emerging markets that will benefit the most. Although a far cry from 2013's "taper tantrum" -- when emerging markets' stocks and bonds fell sharply on fears that a less-accommodative Fed would create a rush of capital out of risky assets -- this tightening cycle has been relatively benign for this asset class.

Still, coupled with various political, economic and social challenges specific to each developing country, a faster-than-expected tightening of monetary policy by the Fed would have led to fast withdrawal of capital from these markets.

This didn't happen and it doesn't look like it will. Data from Capital Economics, a London-based think tank, show that outflows from developing countries have slowed markedly in recent months, while the majority of emerging market currencies have strengthened versus the U.S. dollar since the start of the year.

In the short term, this is positive, because it allows these countries to maintain foreign borrowing at the levels they need. But over the long term, it acts as a brake on their development. That's because markets are the best signal for politicians as to what measures they need to take, and can serve as a deterrent for those with autocratic, despotic tendencies.

Already, democracy is eroding in many countries. In emerging Europe, Hungary and Poland have slipped toward illiberal, closed societies, and let's not even start on Turkey. In Asia, the Philippines' regime looks increasingly brutal. In Latin America, social strife is rising in Venezuela, while Brazil is still reeling from the corruption scandal that has seen President Dilma Rousseff's replacement Michel Temer in danger of being removed himself.

Perhaps the biggest warning comes from South Africa, where the president's recent firing of the respected finance minister triggered a downgrade of the country's credit rating below investment grade. The bond markets did not react as sharply as they should have done to the political crisis and the downgrade, mainly because of the surplus of liquidity caused by the Fed's easy policy.

But unless a change happens, the future looks bleak. Such "multi-year erosion of the democratic fabric of any individual country that finds its way into ratings downgrades and economic pain can eventually lead to situations similar to that of Syria today," warns Simon Quijano-Evans, an emerging markets analyst with Legal & General Investment Management.

This warning rings true not just for South Africa, but for any developing country. The sooner the normal functioning of the markets is restored, the better for democracy, it seems.

BEST IDEAS

REAL MONEY'S BEST IDEAS

News Breaks

Powered by

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.