By Stephanie Jacob
The US Federal Reserve has finally raised interest rates slightly for the first time in years. Will a measured pace of further increases going forward and other factors help emerging markets avoid crisis?
We finally have interest rates liftoff in the US economy after the US Federal Reserve (Fed) announced overnight that it would raise rates from the near-zero levels it was lowered to in 2008, at the height of the Global Financial Crisis (GFC). The Federal Open Market Committee’s (FOMC) historic decision signals the first rate hike since 2006.
The committee unanimously voted to set the new rate at 0.5% from 0.25% previously, a quarter of a percentage increase. The majority of the committee members also forecast that an appropriate rate level at the end of 2016 would be 1.375%, and this suggests that there are likely to be four quarter-point increases over next year.
Janet Yellen
Fed chair Janet Yellen said: “The economic recovery has clearly come a long way, although it is not yet complete… The committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen.”
But what does this mean for emerging markets like Malaysia which have been living with the uncertainty of the Fed hike over this past year? Will confirmation now help or hurt the country’s economy?
Traditionally, Fed hikes are not good for emerging markets. It causes outflows of funds that have been invested in these markets as investing in the US becomes more attractive.
This is especially true this time around, as many emerging markets benefited from the quantitative easing or “easy money” policy of the Fed, which sent significant inflows into economies like Malaysia’s. To an extent, these flows are now reversing and therefore Malaysia has had to deal with substantial outflows over this past year.
Perhaps the biggest loser of these outflows has been the ringgit, as investors sell the local note for foreign currency, in particular for the US dollar.
On the other hand, the Malaysian economy has also been battling with the uncertainty of when the Fed would pull the trigger which has made for a very volatile and nervous environment. On that count, confirmation from the Fed will bring some stability back into the economy.
Zeti Akhtar Aziz
Bank Negara Malaysia governor Zeti Akhtar Aziz has said many times this year that one of the factors affecting the valuation of the ringgit was the policy unpredictability in the major economies of the world. The Fed’s decision reduces some of that uncertainty.
So what will happen this time around?
Well it is early days yet, but Asian markets seem to be reacting positively to the news. Shanghai Composite, Jakarta Composite Index and the FBM KLCI among other have all climbed and are trading in positive territory.
Analysts are hoping that emerging markets may be less severely impacted this time around because they are better equipped. Speaking to Bloomberg, Blackrock emerging markets portfolio manager Amer Bisat highlighted several which he thinks make emerging markets more capable of coping with the hike.
Firstly, he said that emerging market currencies are more flexible than they have been in the past. This allows it to be an adjustment mechanism and therefore allowing the shock coming from the decision can go through currencies.
Secondly, Bisat noted that foreign reserves among the emerging markets are higher than they were during past Fed hikes and he said this provided these economies a cushion which absorbed some of the impact of the hike.
He also highlighted that US dollar debts in many emerging economies are less than they used to be. Bisat said that although emerging markets are generally highly leveraged, hard currency debts are much lower.
So while emerging markets are facing a plethora of other issues, the Fed’s decision for now at least will not have that much of a negative impact.
Commenting about the potential Fed hike several weeks ago, independent analyst Lim Heng Guie told KINIBIZ that given a rate hike was more than likely, what mattered was the quantum of the hikes and the pace of subsequent hikes.
Hopefully the Fed’s quarter point increase and Yellen’s use of the word “gradual” to describe the pace of future hikes decisions will be in line with what markets were and are expecting, and with what they have priced in.
Of course it is early days yet, but hopefully the fact that most of the Asian benchmark indices are trading up and in the black today is indicative that the emerging markets will not tumble into an economic crisis as a result of this rate hike.
GRRRRR!!!
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