- Could the Fed start to normalize its monetary policy earlier than expected? With the USD1.9trn fiscal stimulus package and a new USD2.3trn infrastructure program, we have raised our US GDP growth forecasts to +5.3% in 2021 and +3.8% in 2022. As a consequence, tightening labor market conditions along with higher commodity prices should also lift consumer price inflation to 2.5% in 2021 and 2% in 2022. But we continue to believe that the US Fed will only consider tapering its bond purchases starting in H2 2022 and increasing the Fed Funds Target rate only from H2 2023 onward. And because monetary tightening in the US will certainly generate financial pressures worldwide, we think that the Fed will communicate on its future moves better than it did in 2013, when its announcements surprised markets and caused the taper tantrum. Yet, there is a risk that the Fed may be tempted to normalize its monetary policy earlier, and perhaps again surprise markets due to miscommunication, so Emerging Markets (EMs) may be faced with another potential taper tantrum. Our pattern recognition model confirms that this risk cannot be entirely ruled out.
- Emerging Market initial conditions are more favorable than in 2013, with exceptions. Current account deficits are lower today, credit growth is at more sustainable levels and we expect inflation to remain under control, by and large. EM currencies are likely to remain volatile but we do not forecast a broad-based repeat of the substantial depreciations experienced in 2013-2014, also because real effective exchange rates are currently less strained as currencies already took large hits in 2020. Moreover, monetary policy is currently ultra-loose in many EMs and it should remain accommodative overall in the near future even though a moderate tightening is likely in those countries where inflation exceeds the central banks’ target ranges. Increases in inflation expectations could put pressure on central banks as the need of adapting the monetary policy clashes with the need to support the Covid-19 recovery.
- However, external financing requirements and the steady rise in sovereign debt reveal some weak spots. In six countries, the external debt payments falling due in the next 12 months significantly exceed the level of official foreign exchange reserves (Turkey, Argentina, Ukraine, South Africa, Romania, Chile). Moreover, the steady rise in sovereign debt over the past decade poses a significant risk, in particular for those EMs where the share of non-residents’ holdings of public debt has increased over the last seven years.
- Overall we identify seven EMs particularly vulnerable to the eventual Fed tapering, especially if it is not well communicated, the TUCKANS: Turkey, Ukraine, Chile, Kenya, Argentina, Nigeria, South Africa. A stabilization of the money flows after a complicated 2020 would be crucial, but a pattern of relatively steady inflows into EMs is not yet visible, at least not in a generalized way.
- EMs, in particular some of the TUCKANS, are already experiencing generalized rises in the interest rates of their local currency bonds. In the short term, this is a sign of upcoming volatility. If sustained, it could pose severe threats to debt sustainability, which was already an issue for some of the countries before. However, this spike could be at least partially a consequence of high growth expectations, which would make it less risky than one solely based on US tapering.
Taper Tantrum in 2021-22: Beware of the TUCKANS
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Pablo Espinosa Uriel