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Analysis: Emerging market pain not about to faze U.S.-focused Fed

Turkish lira banknotes are seen in this photo illustration taken in Istanbul January 7, 2014. REUTERS/Murad Sezer

By Jonathan Spicer

NEW YORK (Reuters) - The U.S. Federal Reserve, intent on cutting its stimulus again this week, is not about to blink in the face of a brutal selloff of emerging market assets that could yet gain steam in Turkey, Argentina and elsewhere.

Though the central bank's 16-month-old bond-buying program is meant to boost the U.S. economy, in the past it has lifted currencies and stocks in emerging markets that have benefited from a rush of international investment and the resulting lower interest rates.

Now that the Fed intends to wind down the unprecedented policy accommodation by later this year, those markets - especially in countries with large current account deficits - have dropped hard, prompting policy responses late last week from central banks around the world.

But the turmoil would probably have to escalate dramatically and start to hurt the United States for the Fed, focused on domestic improvements in the world's largest economy, to back down from trimming the asset-purchase program known as quantitative easing, or QE.

"When we started QE ... there were many economies and emerging markets and other places that were very critical of our policy. Now that we're trying to stop it, they've been very critical of our policy," Charles Plosser, president of the Philadelphia Fed, said in a January 14 speech in his hometown.

"We are aware of those things," he added. "But the way the Fed thinks about it is, if the monetary policy that we have is the best for the U.S. economy, then that's the policy that we ought to pursue because a strong U.S. economy would be good for most of the rest of the world."

Such reasoning is held throughout the ranks of top Fed policymakers, who are mandated by law to pursue maximum sustainable employment and steady and low inflation in the United States.

Fed officials privately say they try to be as transparent and predictable as possible so that U.S. policy changes do not shock foreign counterparts. And they point out that countries such as Mexico that better manage their budgets are often unscathed by investors searching for risky or safe-haven assets, depending on U.S. policy changes.


At a meeting that ends Wednesday in Washington, the Fed is widely expected to trim its monthly purchases of Treasuries and mortgage bonds to $65 billion from $75 billion, after it made a similar $10-billion cut at a December meeting.

Fed Chairman Ben Bernanke has said the bond-buying program would likely be completely wound down by later this year, as long as the U.S. economy and labor market continue to improve on the back of a pick-up in growth in the second half of 2013.

Though the Fed has fairly well telegraphed its intentions, last spring emerging markets sold off sharply when Bernanke merely talked of the prospect of reducing QE.

Now that the tapering has begun, the idea of less U.S. stimulus combined with slower Chinese growth and specific concerns in some countries led last week to a full-scale flight from emerging-market assets that could continue this week.

The selloff accelerated on Friday, prompting Argentina to abandon its support for the peso. The day before, Turkey's central bank resorted to what analysts said were its first direct interventions since 2012 in the lira, which hit a record low on Friday.

Central banks of several emerging markets were also believed to have intervened to defend their currencies including India, Taiwan and Malaysia.

The selling did not spare stocks in the United States, where the benchmark S&P 500 index dropped 2 percent on Friday. But, as Dallas Fed President Richard Fischer said this month, he "would not flinch" from trimming the bond-buying even in the face of a stock market correction.

The Fed, which has held interest rates near zero for five years to battle the recession's fallout, could acknowledge the emerging-market turmoil in its Wednesday policy statement. But it is all but certain to continue what Bernanke called "measured" cuts to the asset purchases.

"It takes a pretty severe downgrading of foreign growth to have a noticeable effect of the U.S. economic outlook," said Michael Feroli, chief U.S. economist at JPMorgan.

"Thus far it is not even certain that a few days of international financial stress is enough to change the global economic prospects, much less effect the U.S. economy."

(Reporting by Jonathan Spicer; Editing by David Gregorio)