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For Today’s Emerging Markets, A Less Accommodative Fed Would Be More Bark than Bite

Todd Speed, CFA

In early April, our Calamos Global Equity Team published a post, “Taper Tantrum Redux? History Often Rhymes but It Rarely Repeats”, explaining why we’re not expecting a repeat of the 2013 “Taper Tantrum” experience as the Federal Reserve contemplates removing monetary accommodation.

As we discussed in April, the Fed’s policy framework and higher bond yields we see today are more associated with a stronger global growth outlook than fears of disruptive inflation. Also, emerging market fundamentals are stronger today than they were in 2013 and provide more supportive conditions for emerging economies to navigate asset price reactions.

It seems we’re in good company: In late June, the Federal Reserve published a research note entitled “Are Rising U.S. Interest Rates Destabilizing for Emerging Market Economies?”. In it, the authors further investigate the links between rising U.S. interest rates and the impacts on emerging markets.

Key Findings of the Fed Note

History reveals differences in the “spillovers” of U.S. monetary policy to emerging markets. These spillovers depend on two key factors.  The first of these factors is the reason for the change in U.S. rates—is it driven more by favorable growth prospects or worries about higher inflation? The second key factor is the domestic financial conditions in emerging market economies (EMEs).

These two factors help explain why EMEs were significantly impacted during the hawkish Volcker Fed era of the early 1980s. These factors also explain why EMEs fared well in the mid-2000s, as both the growth landscape and financial conditions were supportive (see chart below).

federal funds rate versus incidence of financial crises in emes

Source: FEDS Notes, Board of the Governors of the Federal Reserve System, “Are Rising U.S. Interest Rates Destabilizing for Emerging Market Economies?” (June 23, 2021 Jasper Hoek, Emre Yoldas, and Steve Kamin.

Conclusion: Higher Treasury yields can have a significant impact on emerging market financial conditions, but the effects “importantly depend on the drivers of higher yields and domestic conditions in EMEs.” We believe both these key factors support the investment case in emerging markets. There may be more bark than bite as we edge toward what is shaping up to be a highly-telegraphed phase of accommodation removal—this may be more of a Taper “Tiptoe” than Tantrum.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be appropriate for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.

As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to the potential for greater economic and political instability.

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