Guess who’s the latest to fret about Fed tapering

“Starting in May, there was a significant re-pricing in global bond markets, which took place largely because of changing monetary policy expectations in the United States – with increased foreign exchange market volatility and stress borne largely by emerging market economies.”…“It cannot be ruled out that ultimate exposures are concentrated among a limited number of entities which may now be more vulnerable to any further severe market shock.”

Okay, that’s a lot of words to digest. But that’s just part of  what the European Central Bank (ECB) said in its latest financial stability report, according to a Financial Times report.

Clearly, emerging markets are not the only ones jittery about a pull-back in the Federal Reserve’s $85 billion a month asset-purchasing program, even Europe is starting to feel the shivers.

The ECB is the latest in a growing list of countries/officials/institutions to voice concerns over what is  now widely being referred to as ‘Fed tapering’.

The main message in the comments above is that the ECB believes there are risks to the eurozone’s financial  system from outside the currency bloc. In particular, the second sentence notes that in the event of a Fed tapering, the eurozone’s  institutional investors are more exposed to bond  markets than its banks, making it difficult to gauge where losses ultimately lie.

In general, it is believed that emerging market assets, such as stocks, bonds and currencies, have been the key beneficiaries of the mammoth Fed stimulus programme.

Investors have typically borrowed funds at cheap rates from the US and poured them into higher-yielding assets like stocks and bonds in emerging markets.

If the Fed tightens the leash on the easy money, the reduced supply could push up interest rates, which, in turn, could prompt investors to pull back money from emerging markets to repay their borrowings.

The first time the Federal Reserve mentioned that it planned to dial back its asset-purchasing programme (back in the summer) , financial markets, especially in emerging countries, threw a ‘taper tantrum’ (stocks, bonds and currencies plunged as investors pulled out money).

Now, the ECB believes Europe could also face similar risks if the Fed were to actually start tapering.

Apart from Europe, which emerging markets are likely to be the hardest hit by the Fed winding down its stimulus? Answer: India, Indonesia, Turkey, Brazil and South Africa, according to Morgan Stanley, which dubbed these nations as the ‘Fragile Five’.

All this serves to remind us, yet again, that the Federal Reserve doesn’t make policy just for US economy, but for almost the entire global economy.  When it takes any action, it affects, for better or for worse, all of us.

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