Powell Must Answer Question Greenspan Raised 20 Years Ago
Powell faces policy paradox as U.S. strength fuels EM stress.
(Bloomberg) -- It was 20 years ago this week that then-Federal Reserve Chairman Alan Greenspan questioned whether the U.S. could remain an oasis of prosperity in an increasingly fraught world economy. Now Jerome Powell is getting his first crack at that puzzle as emerging markets crumble.
The rout in both the stocks and currencies of emerging nations has prompted strategists from JPMorgan Chase & Co. and BlackRock Inc. to warn of contagion sweeping through the markets. It’s also begun to raise questions about the durability of a global economic upswing that just a year ago was being trumpeted as the most synchronous in decades.
The challenge is Powell and his colleagues confront a policy paradox. The stronger the U.S. economy looks, the more compelling the case for higher interest rates.
“There is one force at work that is impacting all emerging markets, and that is the Fed,” said Kristina Hooper, chief global market strategist at Invesco Ltd., which has $988 billion under management. With the Fed raising rates and reducing its balance sheet after buying bonds following the financial crisis, “we’ve got two tightening tools at the same time.”
But a heightened prospect of dearer credit risks ratcheting up pressure on emerging markets, especially those heavily dependent on foreign finance.
“Jay has a complicated landscape to navigate,” said Institute of International Finance chief economist Robin Brooks, referring to the current Fed chairman by his nickname. “The U.S. economy is strong but stresses are building in emerging markets.”
Investors are betting that the Federal Open Market Committee will persevere with its third rate hike this year when it meets this month. They’re less certain of what comes afterward, even though policy makers themselves have provisionally penciled in gradual rate increases through next year and into 2020.
“There are countries like Turkey and others having political challenges, economic challenges,” Minneapolis Fed President Neel Kashkari said Wednesday in an event at Montana State University. “Those could lead to some type of contagion around the world potentially. And then maybe if we have companies exporting to emerging markets, they could be directly affected by that.”
The contradictory forces facing the Fed came to the fore on Tuesday, when stronger-than-forecast U.S. manufacturing data boosted expectations of further rate rises, feeding risk-off sentiment in emerging markets.
More turbulence could be in store if Friday’s release of the monthly U.S. jobs numbers paints a similarly robust picture of the economy. That might particularly be the case if wage growth finally shows signs of accelerating.
Payrolls are projected to have risen 198,000 last month, after increasing 157,000 in July, according to the median prediction of economists surveyed by Bloomberg. Unemployment is forecast to have ticked down to 3.8 percent from 3.9 percent, while annual earnings growth is seen as holding steady at 2.7 percent.
It’s not only the Fed’s slow withdrawal of stimulus from the world economy that emerging markets are having to deal with. They’re being buffeted by other shocks as well, including President Donald Trump’s tariff increases on selected U.S. imports and his sanctions on Russia. And domestic drivers -- such as political uncertainty in Brazil -- are also at work.
Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co., said the Fed’s stance is key. “I’m not looking for the emerging-market cycle to turn until we get closer to the end of the Fed’s tightening cycle,” he told Bloomberg Television on Sept. 4.
That could be some way off.
“At this point what we’re seeing in the EM space is nowhere near enough to give the Fed pause,” said Peter Hooper, chief economist for Deutsche Bank Securities in New York.
Hooper, who spent 26 years at the Fed, said it’s extremely rare for developments abroad to affect U.S. monetary policy. It did happen in 1998, when Greenspan cut interest rates three times in rapid succession as the year-old Asian crisis spread to Russia and began to infect financial markets in the U.S.
Today’s turmoil pales in comparison to the situation back then. Hooper still sees solid global growth this year and next, though perhaps not as heady as before due to the emerging-market stresses.
“Unlike 20 years ago, the underlying fundamentals of emerging markets are generally sound,” said Nathan Sheets, chief economist at PGIM Fixed Income and a former U.S. Treasury undersecretary for international affairs.
Brooks, who was Goldman Sachs Group Inc. chief foreign-exchange strategist before joining the IIF last year, said the Fed probably won’t be inclined to react unless the turbulence spreads to China.
That’s been the U.S. central bank’s modus operandi in recent years. The Fed looked all set to raise interest rates in September 2015 but ended up delaying a move after a tiny devaluation of China’s currency rocked financial markets.
The same thing happened in 2016, as another leg down in China’s currency helped convince the Fed to put off a rate increase planned for March.
“It’s quite important what happens to China,” said David Hensley, director of global economics for JPMorgan Chase in New York. “If it were to look like it were slowing dramatically or to have some real problems with financial stability, that would change the equation.”
--With assistance from Matthew Boesler and Andrew Mayeda.
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