Jock Chan is Head of Treasury Strategy at Monex Europe
Is the world on the verge of an extreme taper tantrum that will see mass panic as funds exit emerging economies? The IMF thinks so – and it’s not alone.
It warns that the US Federal Reserve could spark a ‘super taper tantrum’ when it starts to tighten monetary policy and interest rates begin to normalise. The IMF also advises everyone to brace for a sudden jump of 100 basis points in 10-year Treasury yields along with a soaring dollar.
Certainly the consensus is that long-anticipated rate hikes are about to start, bringing an end to eight years of cheap liquidity. The risk is that this will be a more extreme version of 2013 when hot money flew out of emerging markets, government bond yields spiked and their currencies took a hammering (to all-time lows in some cases) merely based on rumours of the Fed tightening monetary policy.
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These markets are just as exposed today as they were in 2013, if not more so. As the Daily Telegraph’s Ambrose Evans-Pritchard put it “It amounts to a short-squeeze on $9 trillion of external dollar debt outside US jurisdiction, half of it owed by companies in Russia, Brazil, South Africa, China and the rest of the emerging markets.”
Potential consequences of even a small hike by the Fed could result in a mass outflow of funds from emerging market economies, reversing the trend of its accommodative monetary policy in 2009. The question is, when and by how much?
In our opinion, a rise from the Fed at the back end of this year is looking more and more likely. Will we then see an even more extreme reaction than in 2013? Our view is that this may not in fact be the source of extreme volatility the IMF warns about.
The Fed has, after all, repeatedly hammered home the fact that interest rate hikes will be very slow – 0.25 ticks at a time – followed by long periods of reassessment. It will signal every subsequent move well in advance, meaning that it’s more likely we will only see an increase in volatility once the central bank steps back from forward guidance.
But this does not mean we should be complacent because there is still much else to worry about.
Volatility, panic and problems in emerging markets are more likely to be sparked by the wild cards, the unforeseen events.
The oil price is perhaps the biggest source of uncertainty and volatility. After taking the world by surprise late last year, some forecasts suggest prices will tank again. That would pose problems for Nigeria, Russia and other oil-focused economies. Equally we could see prices rise if there’s trouble in the Middle East.
The other big theme to watch is China’s slower economic growth rate. We are already seeing volatility in the equities market and we mustn’t forget its importance as a source of external demand for the ‘taper tantrum’ economies.
The Greek situation in the Eurozone poses a risk too, although that should be mitigated by the fact that everyone has been preparing for it for so long. Eurozone banks should be able to handle any potential Greek exit, but it is another ‘known unknown’ to think about.
So even if the realization of Fed rate hikes does not spark an emerging market rout, having made its plans quite so clear, very real risks remain.
This means every business must still systemically evaluate its exposure. With all this uncertainty, it seems likely that we will see large spikes in volatility and structural shifts in lots of currencies. Investors need to ask: Are our business models exposed to the markets we operate in and are we exposed to currency, commodity prices or interest rates in any of these countries?
Businesses need to look at the currency tools available that can minimise balance sheet risk against the market uncertainty of ‘taper tantrum’. Even when historic currency shifts and market speculation suggests adopting a more speculative approach to risk mitigation, they need to consider how they deal with asset management.
Those that don’t take a strategic approach to managing these risks will be exposed to the whims of an increasingly uncertain picture.