U.S. Monetary Policy Has Global Implications

The talk of “tapering” (reduction in asset purchases by the Fed) has caused significant market volatility over the last few weeks.  This is especially true for emerging market economies such as India, which have been net beneficiaries of the easy money policies put in place by developed market central banks around the world.  Investors have viewed these emerging economies as fast-growing, high-return options in an overall low interest rate environment.  With rates rising in the U.S., this trade is reversing itself and causing a significant drop in the currencies of emerging markets.  Capital outflows and currency devaluation are forcing central bankers from emerging economies to call on the U.S. to tread cautiously when setting monetary policy.  While we doubt that the Fed will set monetary policy based on the desires of emerging markets, the recent market stress overseas does have implications here at home.  In an effort to support their rapidly falling currencies, emerging market central banks could sell dollars (by selling Treasury bonds) in order to fund purchases in their own currency.  This technical pressure on our bond market will likely be offset by the slow-growth, low-inflation environment that is occurring around the world.  With lots of puts and takes, this is a good reminder that the financial system is truly global in nature.