Why The Fed Didn't Mention The Turmoil In Emerging Markets

Vincent ReinhartREUTERS/Carlo AllegriMorgan Stanley chief U.S. economist and former FOMC secretary Vincent Reinhart explains.

Over the past few days, a bout of global risk aversion has intensified strains in emerging markets, and several big EM central banks (India, Turkey, and South Africa) have caught investors by surprise by hiking interest rates.

One of the big questions market participants wanted answered heading into the release of the FOMC’s latest decision on monetary policy on Wednesday afternoon was whether or not the Committee would acknowledge these strains, which have at times in the past few trading sessions been major drivers of price action in some of the world’s biggest markets, and have contributed to souring investor sentiment.

After all, the future isn’t looking too sunny for emerging markets as long as the FOMC sticks to its loosely data-dependent plan to reduce bond buying at a constant rate at every meeting until it is no longer buying bonds later this year, and if the past week is any indication, that means the outlook for global risk appetite could become a little cloudy as well.

The FOMC ended up pressing ahead, tapering the pace of monthly bond purchases it makes under its quantitative easing program by $US10 billion to $US65 billion.

And in its statement, it did not say a word about emerging markets.

Why not?

There were two reasons, according to Morgan Stanley chief U.S. economist Vincent Reinhart, who served as the secretary and economist of the FOMC from 2001 to 2007.

“First, the Federal Reserve is a domestic-centric institution,” says Reinhart.

“They didn’t show much love for EM in May to September of last year’s sell-off — it’s not surprising that they didn’t mention it this time around.”

But there is another reason, which you may not be familiar with if you haven’t dug into old transcripts from FOMC meetings of the pre-crisis era: the policy statement is drafted two weeks in advance of the actual meeting.

“The FOMC statement is very inertial,” explains Reinhart.

“It’s tough for Committee members to incorporate late breaking news. So much of it is drafted in advance.”

That’s not to say that the FOMC couldn’t have included a mention of emerging markets in the statement if it really wanted to, and ultimately the statement is subject to the decision voted on at the meeting itself — but modifying the language to reflect a concern that may be on the rise but has no immediate bearing on policy action is not as straightforward as it might seem.

“In my experience, which is not recent, a draft [of the statement] is seen by the chairman about two weeks in advance and circulated to the FOMC one week ahead,” says Reinhart.

“Having gotten negotiated agreement ahead of time, the temptation is not to do more than minor fiddling. This is evident in the published transcripts.”

A discussion of recent strains in emerging markets will, on the other hand, likely show up in the minutes from this meeting, which will be released by the Fed on February 19.

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