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IMF Taper Forecast: Smooth With Some Heavy Ripples
Now that US politicians seem likely to avoid the epic disaster
of a debt default, we can all return our attention to the mere
unprecedented historic challenge of weaning the world's advanced
economies off the zillions of dollars their central banks have
been printing. One educated guess of how that process will work
came recently from the International Monetary Fund, and it is
largely reassuring unless you have been stuffing your basement
with gold coins anticipating the demise of all "fiat" currencies.
The IMF annual meeting in Washington last weekend was one of the various global events overshadowed by the political face-off a few blocks away, which was not necessarily a bad thing. The conclave tends to be a hot air fest-cum-gravy train of global proportions, the best fed people from around the world gathering to fret elegantly over some excellent canapes. But the IMF also has many fine economic minds toiling away in the basement, and when they get their teeth into some dense multilateral conundrum, the results are worth noting.
So the good news is the Fund thinks the world can actually taper off what it calls Unconventional Monetary Policies, or UMPs, gradually without massive disruption. "Central banks have the tools to facilitate a relatively smooth exit," IMF researchers conclude in a report that was showcased at the annual meeting. In "simple models … long rates would make a one-time jump" followed by a new period of stability and contentment.
The bad news is that this sanguine result depends on the public relations skills of central bankers, a group that historically takes opacity and unfathomability as a badge of honor. "The primary tool to contain instability is communication," the Fund writes. Janet Yellen and her counterparts-to-be must be clear and consistent on their timing and guideposts for lowering the UMP doseage, though of course not so clear that they deprive themselves of room for tactical maneuver. If the bankers fail to thread this needle, "concerns about the timing of exit may add to the noise around short rate expectations." This is IMFspeak for the panic that gripped global securities markets in May, when Ben Bernanke hinted it might be time to start reining in UMP American style.
The IMF also implies that the coming diminution of monetary stimulus will be rougher on emerging markets, which it calls "non-UMP countries," than on the metropoles that have been running their printing presses. The great boats of the US, Europe, and Japan may rock a bit if and when their central banks tighten, but the ripples could shake smaller peripheral economies. This is of course what happened after the Bernanke Shock in the spring.
An appendix to the Fund's report rates 11 top emerging markets on "exposure" and "resilience" to an environment of tighter money in the core economies and consequent decreased yield-seeking flows heading outward. Its findings partially overlap those of Morgan Stanley, which created a new market category this summer called the Fragile Five: India, Indonesia, Turkey, South Africa, and Brazil.
The first three of these also look highly vulnerable to "external shocks" by the IMF's calculus. Yields on Turkey's sovereign bonds jumped a world-beating 95 basis points, for instance, after Bernanke's taper hint in May, while US rates (initially) climbed by 25 beeps. That made Turkey the champion in the exposure category. Indonesia, for its part, has almost nothing to offer by way of resilience. "Domestic capital markets are shallow," the Fund summarizes dourly. "In the event of significant outflows, fiscal policy space seems limited."
China and Russia, with minimal debt and huge current account surpluses, are best positioned to shrug off tectonic monetary shifts beyond their borders. Brazil and South Africa also have substantial resilience factors to offset their exposure to foreign hot money. Brazil's ace in the hole is a reserve horde of $374 billion that it has been using to stabilize its flailing currency. Its banks are also holding large reserves that could be pared to add domestic liquidity, the Fund writes. In South Africa, "large domestic investors have the potential to substitute foreign investors if these withdraw funding."
Yet if a shift away from UMPs promises new volatility for emerging markets, inaction is treating them just fine for the moment. The iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) has climbed by 16% since the Bernanke mini-crash subsided in late June, double the 8% gain posted by the S&P 500 (INDEXSP:.INX). So just in case you believe that the Fed, ECB, and BOJ are not tightening any time soon, EM could be the place to be.