Tuesday, August 20, 2013

Emerging Market Currencies Scared Down By Fed Taper Talk

BRIC currencies are sinking like stones.  That's good for the dollar in the short run because the dollar still looks like the cleanest dirty shirt in the clothing pile.  India's rupee is hitting all-time lows.  That's good for anyone in the US who wants to import curry spices from India or go there for cheap medical tourist surgery.  Australia is not an emerging market but it remains a standout case in non-US markets.  Australian debt is in demand even though its currency is falling.  Some non-Australian investor is thus getting a major bargain.

Please don't take rising real interest rates in the US as some kind of vote of confidence in the US dollar.  The flight from riskier currencies does make the US dollar more attractive but it also makes capital more costly inside the US.  This will eventually drive US equity markets down as higher mortgage rates hurt consumers and higher borrowing costs hurt business cash flows.  Whatever panicky QE buying the Fed then conducts in response to deteriorating fundamentals will make currency traders lose their confidence in the dollar.  I thus expect the dollar to be the last domino to fall among the developed economies' currencies.

If the Fed's hints at tapering were intended to drive investors out of emerging markets and into US Treasuries and equities then it was the most brilliant head-fake ever from a central bank.  I don't give the Fed's leaders that much credit, so the more likely explanation is that these emerging market currency selloffs are the unintended consequences of the Fed's risk-off hint.  Central banks are not the all-powerful meta-attractors they pretend to be.  Monetary policies have unintended consequences, especially when they inflate asset bubbles all around the world.  Global markets have postponed the run on the dollar for now.