Fed chair Janet Yellen Yin Bogu/ZumaPress

Emerging Markets After the Fed Hikes Rates

The prospect that the US Federal Reserve will start exiting zero policy rates later this year has fueled growing fear of volatility in emerging economies’ currency, bond, and stock markets. But, with a few exceptions lacking systemic importance, widespread distress and crises need not occur.

NEW YORK – The prospect that the US Federal Reserve will start exiting zero policy rates later this year has fueled growing fear of renewed volatility in emerging economies’ currency, bond, and stock markets. The concern is understandable: When the Fed signaled in 2013 that the end of its quantitative-easing (QE) policy was forthcoming, the resulting “taper tantrum” sent shock waves through many emerging countries’ financial markets and economies.

Indeed, rising interest rates in the United States and the ensuing likely rise in the value of the dollar could, it is feared, wreak havoc among emerging markets’ governments, financial institutions, corporations, and even households. Because all have borrowed trillions of dollars in the last few years, they will now face an increase in the real local-currency value of these debts, while rising US rates will push emerging markets’ domestic interest rates higher, thus increasing debt-service costs further.

But, although the prospect of the Fed raising interest rates is likely to create significant turbulence in emerging countries’ financial markets, the risk of outright crises and distress is more limited. For starters, whereas the 2013 taper tantrum caught markets by surprise, the Fed’s intention to hike rates this year, clearly stated over many months, will not. Moreover, the Fed is likely to start raising rates later and more slowly than in previous cycles, responding gradually to signs that US economic growth is robust enough to sustain higher borrowing costs. This stronger growth will benefit emerging markets that export goods and services to the US.

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