July 28, 2019
With the big Fed meeting this week, there continues to be some debate about whether they will cut by 25 basis points or 50.
But the direction matters more than the magnitude.
It signals the end of the Fed’s “policy damage” to emerging markets.
Higher U.S. rates have meant a stronger dollar. And with the economy moving north, the dollar moving north and rates moving north, global capital has moved toward the U.S. — and away from riskier emerging markets.
It's not that the U.S. economy can't handle a 2.5% Fed Funds rate, it's that the EM world can't handle it (in the current post-financial crisis economic environment).
As the Dallas Fed put it last year: “Emerging economies have suffered a general decline in forecast GDP growth … The tightening of monetary policy in advanced economies, both through rate hikes and other policy actions such as forward guidance, results in capital outflows from emerging economies with low reserves relative to their foreign debt.”
This official direction change from the Fed should weaken the dollar. Moreover, a key piece in the continuation of the global economic recovery will likely be a weaker dollar.
It will drive a more balanced U.S. and global economy, and it will reflect strength in emerging markets (i.e. capital flows to emerging markets).
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