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Fed 2nd round taper & Emerging Markets (EMs) crises: 3rd Jan 2014

By Musabbir Mazhar

As expected, the Fed continued its Bond purchases tapering as announced on Wednesday Jan 29th – S&P 500 went down 1% on the news – The Fed will be buying 65$ Billion in Agency MBSs and LT Treasuries starting February – I see the fed continue its tapering program to relieve the risks of inflated asset prices. Market volatility was very high as indicated by a jump of the Volatility index VIX.

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In the Emerging markets (Ems) we saw a currency crises as well as stock markets negatively reacting as a sort of direct consequence of the fed taper.

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Let’s go back – after the crises when Fed started off with QE, EMs backed with the decision and there were huge inflows of capital in the regions which definitely caused their EM currencies to appreciate as well asset prices to go up.

Now that capital flow is in the opposite direction – the countries who peg their currencies against the US dollar are seeing their currency lose value – the central banks of the EMs don’t really have other ways than to deplete their Foreign Currency reserves to keep the peg. And as Fed continues to taper – this will be difficult to maintain if not everything breaks loose for certain countries.

Argentina Foreign Exchange reserves fell below $30B as its currency devalued which is alarming. Now if the central bank doesn’t act – a devaluation of currency would cause import prices to go up as well as foreign demand for domestic goods to go up – causing INFLATION and inevitably forcing the CB to push the interest rates up. This is going to be crazy for countries like Argentina where inflation is estimated to be 30% or HIGHER as many estimates!

Turkey increased their interest rate from 7.75% to 12% as its currency slid in recent weeks. Venezuela devalued its currency by over 40%.

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