(Bloomberg Opinion) -- In the past, emerging markets looked to the Federal Reserve for cues about monetary policy. Increasingly, they’re turning to the yield curve. Chairman Jerome Powell must regain control of the narrative at Jackson Hole this weekend before his equivocation leads to deeper turmoil in developing economies.
On Thursday, Bank Indonesia cut its benchmark policy rate by 25 basis points to 5.5%, the second consecutive maneuver after starting an easing cycle in July. Most economists polled by Bloomberg had expected the central bank would hold.
This was no easy decision for Jakarta. Indonesia – a so-called twin deficit nation, with fiscal and current-account shortfalls – is one of the most vulnerable emerging markets. Foreigners hold roughly 40% of the country’s sovereign bonds, so the economy is sensitive to outflows: Investors abroad yanked roughly $430 million from Indonesia’s high-yielding bonds this month alone, even as yields in other parts of the world sank below zero. The rupiah has weakened 1.5% against the dollar in the first three weeks of August.
Textbook economics would say that another rate cut would accelerate that slide. And yet Bank Indonesia is braving the storm.
Indonesia’s central bankers aren’t simply reckless. Rather, like the rest of the market, they’re looking past the Fed’s July meeting minutes – which indicated its cut was merely to “insure against” slower growth and inflation. A more reliable indicator has become the bets Fed funds futures traders are making. That metric implies almost 65 basis points of reductions this year, after a closely watched part of the yield curve this month inverted for the first time since 2007, an occurrence that has reliably predicted past recessions.
Can you blame Jakarta for deviating from the Fed’s official narrative? The central bank “can’t put a back-to-back consistent message together. It is different at every single meeting,” Jeffrey Gundlach, the chief executive of DoubleLine Capital LP, said this week. As recently as late December, the Fed was still in the midst of tightening. By July, Powell was talking about a “mid-cycle adjustment.”
Meanwhile, U.S. President Donald Trump has been busy bullying the Fed into faster and deeper rate cuts on Twitter, putting blame for a stronger dollar, the inverted yield curve, and the possibility of a recession at the Fed’s feet. While Americans may still believe in the independence of their central bank, emerging-market central bankers may start to think otherwise. The president surely seems to be getting what he wants.
Compared with many emerging markets, the U.S. economy isn’t doing that badly. It’s like a Christmas tree – some lights are flashing red but plenty are flashing green, as former Fed official Nathan Sheets put it recently. At this weekend’s Jackson Hole, Powell needs to pick a color. If emerging-market central banks begin to trust fickle markets over the Fed, we’re in for a volatile holiday season.
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Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
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