Daily Commentary BY THE CURVE TEAM –

Concerns Grow As Emerging Markets Capitulate

29th of June, 2018

A sense of complacency continues to air across developed markets as the carnage in emerging markets as well as China has so far remained largely contained. Meanwhile there are some concerns growing amongst Fed members around the pace of monetary policy normalisation.

The carnage across emerging markets has continued as the impact of monetary policy normalisation continues to spread. It isn’t just the small markets either with the Indian Rupee hitting an all time low yesterday and the Chinese Yuan continues to slide. It’s putting pressure on interest rate markets as well as equity markets in these countries but so far the emerging market malaise remains largely contained for now.

While those following emerging markets are concerned about the pace of policy normalisation in the US, there are members of the Fed that are getting concerned for other reason.

One of those members is St Louis Fed President James Bullard who overnight said that “Inflation expectations in the US remain somewhat low, suggesting that further normalisation may not be necessary to keep inflation near target.”  He then added that “A reasonable policy going forward may be to temper the pace of normalisation.”
He is also worried that the pace of normalisation is increasing the risk of inverting the yield, saying “it is unnecessary for the FOMC to be so aggressive as to invert the yield curve.”

The inversion of the curve has so far largely been driven by structural forces, such as overnight rate hikes and the US Treasury focusing on the short end for its borrowing requirements at present. However Bullard is concerned that the market might interpret it as a negative sign.

An inverting yield curve is often associated with an looming recession. That seems unlikely at the moment as the US economy is quite strong at the moment and the full effect of tax changed and fiscal stimulus are yet to have their full impact.

Bullard isn’t currently a voting member on the FOMC committee and his view goes largely against the current rhetoric from official Fed statements. Despite the risk, the Fed’s policy decision will remain driven by what is happening in their back yard unless or until the carnage in offshore emerging markets starts to impact the US.

David Flanagan

Director - Interest Rate Markets