Fed gifts emerging markets a lifeline at expense of euro, yen

[NEW YORK] Emerging markets have a friend in Janet Yellen.

Policy makers from Asia to Latin America can enjoy a reprieve from a 19 per cent slump by their currencies over the past year after the Federal Reserve kept rates near zero on Thursday, stemming outflows from these economies. Their counterparts in Europe and Japan aren't so fortunate; they're still waiting for a US rate rise that would reduce pressure to bolster easing at home.

Ms Yellen heeded calls from the World Bank and International Monetary Fund to avoid destabilising global markets with the Fed's first rate increase in almost a decade. Volatility soared in August across currency, bond and stock markets amid concern slowing growth in China would weigh on the global economy, elevating the stakes for US monetary policy. Officials are watching developments in China and emerging markets, Ms Yellen said Thursday.

"The World Bank was urging the Fed not to raise rates, and a lot of emerging-market countries at the G-20 were saying don't raise rates," said Greg Anderson, the global head of foreign- exchange strategy at the Bank of Montreal. "But for the European Central Bank and the Bank of Japan, their currencies strengthen when there's volatility and they want weak currencies. The best way for them to achieve weak currencies is for the Fed to hike." Emerging Problems Upheaval surrounding any rise in US borrowing costs could lead to a "sizable drop" in capital flowing into developing nations, creating formidable challenges for policy makers, the World Bank warned this week.

The Fed seems to have taken that on board, with Ms Yellen noting that money has already left these countries and saying officials are scrutinizing risks stemming from China and other emerging markets for signs they will affect the US The word "China" or "Chinese" was mentioned 11 times in the Fed's Beige Book released this month, with the Boston, San Francisco and Dallas districts citing the Asian nation's slowdown as weakening demand for products including chemicals and high-tech goods.

A gauge of emerging-market currencies climbed as much as 0.8 per cent from Thursday's low following the Fed announcement. The measure extended its longest rally since April 2014 after touching the lowest in more than a decade earlier this month.

"For emerging-market central bankers, the Fed has given them some much-needed breathing room," Jonathan Lewis, a principal at New York-based Samson Capital Advisors LLC, said Thursday. The firm oversees US$7.4 billion. "Postponing a Fed tightening gives these central bankers room to be more accommodative, without their actions being offset by a tighter Fed." Conversely, ECB President Mario Draghi and BOJ Governor Haruhiko Kuroda face an uphill struggle to renew weakness in the euro and the yen. After slumping in the first half of the year, the two currencies have acted as safe havens amid the China and Fed uncertainty, strengthening more than any of their 10 developed-nation peers over the last three months, Bloomberg Correlation-Weighted Indexes show.

The euro advanced 1.3 per cent to US$1.1435 as of 5 pm in New York, while the yen rose almost 0.5 per cent to 120.01 per dollar. The Bloomberg Dollar Spot Index fell 0.6 per cent, its steepest slide since August.

"I'm not sure the ECB will be happy if the euro uptrend continues," said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan Chase & Co in Sydney. "It's about containing downside risks to the inflation story for them and a stronger euro doesn't help with that." Economists from Goldman Sachs Group Inc and Citigroup Inc were among those projecting the BOJ will boost stimulus on Oct 30 even before the Fed's decision not to raise US rates.

Mr Kuroda and his board left in place on Tuesday in Tokyo their programme to increase Japan's monetary base at an annual pace of 80 trillion yen (S$931 billion). The governor repeatedly told reporters that policy makers sees a gradual recovery continuing in the economy, while also saying the bank wouldn't hesitate to ease if there was some danger of prices not rising to its 2 per cent target.

"Money is going out of the US dollar because the Fed isn't raising rates but it will flow into less risky currencies like euro and yen," said Imre Speizer, a senior market strategist at Westpac Banking Corp in Auckland. "Central banks like the ECB and Bank of Japan will be waiting for the smoke to clear and see what currency trends emerge over the weeks ahead as to implications for their own policies."

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