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posted on 26 March 2016

Emerging-Market Debtor Nations Likely To Follow Fed Rate Boosts

from the Dallas Fed

-- this post authored by J. Scott Davis

A Federal Reserve interest rate increase can lead to capital flows reversing and exiting emerging markets. Central banks in emerging markets that are highly dependent on outside capital will be tempted to match the Fed increase in an attempt to curb capital flight.

Mexico's central bank, Banco de México, rescheduled its monetary policy meetings in 2015 to occur immediately after those of the Federal Reserve. Mexican policymakers knew that the Fed's liftoff from a near-zero interest rate policy was imminent, and they wanted to be in a position to increase their own extraordinarily low rates as soon as their northern counterpart acted.

Mexican central bankers sought to prevent a sudden shift in capital that would result in a sharp depreciation in the peso. When the Fed increased interest rates by 25 basis points (0.25 percentage points) on Dec. 16, Banco de México matched it with a 25-basis-point boost on Dec. 17.

The tendency for a central bank in an emerging market to mimic the monetary actions of a central bank such as the Federal Reserve is well-documented.3 Usually, the intention is to forestall a shift in capital flows that would lead to a sharp appreciation or depreciation of the currency.

[click on image below to continue reading]

Source: research/eclett/ 2016/el1601.pdf

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