In recent months, the Federal Reserve has drawn a lot of heat from asset managers for letting inflation spiral out of control and now risking a recession with rapid rate hikes.
The chorus of complaints develops around its perception in the market. “If the Fed doesn’t do its job, so will the market,” wrote Pershing Square Capital Management founder Bill Ackman. US Fed “The risk is slipping ahead in a no-win conversation that is more familiar to developing countries, which lack policy credibility,” said Mohamed El-Erian, chief economic adviser at Allianz SE, in a column for Bloomberg Opinion.
Industry stalwarts have reasons to be angry. Data due Wednesday will likely point to consumer inflation hitting a four-decade high, forcing the Fed to brace for another 75-basis point increase in July. In just four months, the spread between the 10-year Treasury bond and the two-year note, traditionally a reliable barometer of recession risk, tripled to the upside. The International Monetary Fund cut its growth projections for the US economy this year and next.
Meanwhile, some time-tested portfolio risk management methods, such as hedging US equity exposure with long-run treasuries, have been broken. Not only did both the S&P 500 and the Treasury deliver negative returns this year, but the relationship between the two asset classes has turned quite positive.
Undoubtedly, the US markets have been awkward lately, but everything is relative. Given global fund flows, it is hard to argue that investors have lost faith in the Fed.
Rather, developing economies have borne the brunt of the shock. Investors pulled out more than $50 billion from emerging market bond funds this year, the most severe in at least 17 years. Compared to the US Redemptions on bond funds have remained largely constant; Sovereign debt also saw inflows, despite a 7.5% year-on-year decline.
This is because the Fed is blessed with a currency that is headed in the right direction. A strong dollar, which is essential to containing domestic inflation, prevents portfolio money from fleeing US assets.
Emerging markets, on the other hand, do not have such a luxury. Central bankers there are stuck in a lonely focus on inflation, reacting more aggressively than expected, and still falling short of keeping pace with the dollar. The weakness of their currency, in turn, drives up domestic prices in everyday products ranging from wheat to natural gas.
Hungary, for example, rose by a massive 185 basis points to 7.75% at the end of June, the biggest rate move since 2008. But the boost to the forint against the dollar and the euro quickly evaporated. This year, Hungary’s currency has fallen nearly 20% against the dollar, despite its policy rates rising 5.35 percentage points.
Granted, the Fed is also focused on inflation right now. But at least it’s not in a game of cat and mouse with any other major central bank. It may try to strike a balance between inflation and economic growth.
US market players have been able to consider when the Fed could start cutting rates again – the second quarter of 2023 if futures markets are to be believed. This thought exercise is not even on the table for most developing countries right now. The markets haven’t completely lost faith in the Fed.
This story has been published without modification in text from a wire agency feed. Only the title has been changed.
The US Fed Isn’t Falling Into The Emerging Markets Trap
In recent months, the Federal Reserve has drawn a lot of heat from asset managers for letting inflation spiral out of control and now risking a recession with rapid rate hikes.
The chorus of complaints develops around its perception in the market. “If the Fed doesn’t do its job, so will the market,” wrote Pershing Square Capital Management founder Bill Ackman. US Fed “The risk is slipping ahead in a no-win conversation that is more familiar to developing countries, which lack policy credibility,” said Mohamed El-Erian, chief economic adviser at Allianz SE, in a column for Bloomberg Opinion.
Industry stalwarts have reasons to be angry. Data due Wednesday will likely point to consumer inflation hitting a four-decade high, forcing the Fed to brace for another 75-basis point increase in July. In just four months, the spread between the 10-year Treasury bond and the two-year note, traditionally a reliable barometer of recession risk, tripled to the upside. The International Monetary Fund cut its growth projections for the US economy this year and next.
Meanwhile, some time-tested portfolio risk management methods, such as hedging US equity exposure with long-run treasuries, have been broken. Not only did both the S&P 500 and the Treasury deliver negative returns this year, but the relationship between the two asset classes has turned quite positive.
Undoubtedly, the US markets have been awkward lately, but everything is relative. Given global fund flows, it is hard to argue that investors have lost faith in the Fed.
Rather, developing economies have borne the brunt of the shock. Investors pulled out more than $50 billion from emerging market bond funds this year, the most severe in at least 17 years. Compared to the US Redemptions on bond funds have remained largely constant; Sovereign debt also saw inflows, despite a 7.5% year-on-year decline.
This is because the Fed is blessed with a currency that is headed in the right direction. A strong dollar, which is essential to containing domestic inflation, prevents portfolio money from fleeing US assets.
Emerging markets, on the other hand, do not have such a luxury. Central bankers there are stuck in a lonely focus on inflation, reacting more aggressively than expected, and still falling short of keeping pace with the dollar. The weakness of their currency, in turn, drives up domestic prices in everyday products ranging from wheat to natural gas.
Hungary, for example, rose by a massive 185 basis points to 7.75% at the end of June, the biggest rate move since 2008. But the boost to the forint against the dollar and the euro quickly evaporated. This year, Hungary’s currency has fallen nearly 20% against the dollar, despite its policy rates rising 5.35 percentage points.
Granted, the Fed is also focused on inflation right now. But at least it’s not in a game of cat and mouse with any other major central bank. It may try to strike a balance between inflation and economic growth.
US market players have been able to consider when the Fed could start cutting rates again – the second quarter of 2023 if futures markets are to be believed. This thought exercise is not even on the table for most developing countries right now. The markets haven’t completely lost faith in the Fed.
This story has been published without modification in text from a wire agency feed. Only the title has been changed.
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