After a few quarters of strong recovery in economic activity — accompanied by inflationary pressure — in the United States and Europe, their central banks have sent clear signals about slowing down their massive asset purchase programmes.
In the United States, Federal Reserve Chairman Jerome Powell clearly indicated that the Fed will start “tapering” its quantitative easing (QE) programme this year. But a decision on increasing the policy interest rate will be made later, once the Fed believes that full employment and an average inflation target around 2% have been met.
Markets are expecting more details about tapering plans from the Fed meeting on Sept 21 and 22. However, SCB CIO expects the Fed to officially announce its QE tapering at the subsequent meeting on Nov 2-3. In any case, details about the pace and composition of tapering will be closely watched by markets.
The European Central Bank, meanwhile, said last week that it would scale back its Pandemic Emergency Purchase Programme (PEPP). However, ECB President Christine Lagarde declined to use the market-sensitive word “tapering”, saying the bank was just “recalibrating”. That’s because it still has another QE initiative, known as the Asset Purchase Programme (APP), to continue buying assets in the euro zone.
Meanwhile, the central banks of most emerging market (EM) countries continue to keep policy ultra-easy to support economic recovery, with the exceptions of some that are experiencing high inflationary pressure from surging food prices, such as Brazil, Russia and Turkey. In the developed world, the South Korean central bank also raised its policy rate recently to address surging house prices and household debt.
Returning to the US, the Fed QE taper will be the key financial market event in the last quarter of 2021. But compared with 2013, the last time policymakers started to turn off the money tap, this time market participants, including the major central banks such as the Fed and the ECB, have a playbook.
To avoid a repeat of the “taper tantrum” that rattled financial markets in 2013, the Fed has been sending frequent and clear signals to markets of its intentions. Consequently, we believe the impacts of tapering this time are likely to be not as severe as in 2013, as the rise in US Treasury yields is likely to be gradual. However, impacts across global financial markets, especially equity markets, could be quite similar to those in 2013.
The 2013 tapering playbook suggests that where equity markets are concerned, US markets should see limited impacts in terms of a correction and recovery period, followed by European, Japan and other North Asian markets (except China). Emerging markets in 2013 saw large corrections in their currency, bond and equity markets as well as much slower recovery period.
In 2013, in addition to the surprise taper by the Fed, a number of emerging economies had weak external stability, characterised by high current account deficits and insufficient foreign reserves. And, prior to the Fed announcement, EMs had also experienced huge foreign capital inflows, resulting from a flood of liquidity from QE programmes.
According to the International Monetary Fund (IMF), four key economic indicators — growth, inflation, the current account and foreign reserves — are key determinants when assessing the immunity of emerging markets to a tapering episode. The so-called “fragile five” countries with weak immunity — Brazil, India, Indonesia, South Africa and Turkey — experienced large adverse effects from the 2013 taper.
The next question is how ready emerging markets are for tapering today. Compared with their immunity factors in 2013, most have improved their current accounts and foreign reserves, with Turkey a notable exception.
However, the key concern is weak growth, a consequence of trade tensions and the Covid-19 pandemic. Similar to many of their peers, Asean emerging markets have a weak growth outlook. In Thailand, growth in 2012 and 2013 averaged 5% a year, partially supported by the recovery and massive stimulus after the flooding crisis in 2011. By contrast, the economy is forecast to shrink by an average of 1.8% for 2020 and 2021, according to an IMF forecast in April this year.