The Federal Reserve has been nothing if not accommodative in its monetary policy since the beginning of the late-2000s recession. And as the U.S. labor market has recovered more slowly than other corners of the economy, the Fed has seen fit to keep interest rates low for an extended period of time, risking inflation while hoping for an increase in hiring.
One of the side effects of the U.S. Federal Reserve's decision to maintain rock-bottom interest rates has been an exodus of investors to other currencies, specifically those in emerging markets that offered an opportunity for greater returns. Now, however, the investment community has collectively decided that the Fed is on the brink of shifting its focus toward mitigating inflation, by either dialing back its $85 billion-a-month quantitative easing plan or by raising interest rates. Investors have therefore begun to take their money out of emerging markets like Indonesia, Brazil, South Africa, Turkey and India in order to put it back into the U.S.
India's currency, in particular, is crashing at an alarming rate, according to NACM Economist Chris Kuehl, PhD. "The currency crisis in India is deepening faster than the government can cope," he said. "For all intents and purposes, the rupee is in total freefall as it sets new records against the dollar and other major currencies every day."
Still, the reason for the investment community's sudden certainty that the Fed will raise interest rates is something of a mystery. "Investors are changing their minds and have concluded that the U.S. Federal Reserve is on the edge of shifting its policy and hiking interest rates. There has been nothing to suggest that this is the plan, but enough investors have decided that there will be a shift to cause many to pull out of the emerging markets so that they can buy into the U.S. while prices are still low," Kuehl said. "At some point, the logic holds that these assets will be priced higher and those that invest now can reap a reward."
Part of this new-found belief in an imminent policy change at the Fed stems from the controversy surrounding who will lead the Fed after current chairman Ben Bernanke's term ends on January 31, 2014. The two apparent choices are former Treasury Secretary Larry Summers and current Fed Vice Chair Janet Yellen. "If Larry Summers is chosen there is a belief that he will be more hawkish and more likely to raise interest rates sometime in 2014," said Kuehl. "The selection of Janet Yellen would be reassuring to those who want to see an extension of the loose policy that has defined the Fed since Bernanke started to react to the recession."
Meanwhile, as this drama plays out in the U.S., the financial turmoil in emerging markets will continue and the situation facing India and other similarly situated countries will become increasingly dire.
- Jacob Barron, CICP, NACM staff writer