by Joshua Aizenman, Mahir Binici and Michael M Hutchison, Voxeu.org
In 2013, policymakers began discussing when and how to ‘taper’ the Federal Reserve’s quantitative easing policy. This column presents evidence on the effect of Fed officials’ public statements on emerging-market financial conditions. Statements by Chairman Bernanke had a large effect on asset prices, whereas the market largely ignored statements by Fed Presidents. Emerging markets with stronger fundamentals experienced larger stock-market declines, larger increases in credit default swap spreads, and larger currency depreciations than countries with weaker fundamentals.
The quantitative easing (QE) policies of the US Federal Reserve in the years following the crisis of 2008–2009 included monthly securities purchases of long-term Treasury bonds and mortgage-backed securities totalling $85 billion in 2013. The cumulative outcome of these policies has been an unprecedented increase of the monetary base, mitigating the deflationary pressure of the crisis. The resultant lower interest rates and flattened yield curve improved financial conditions and helped stimulate real economic activity, yet the QE policy raised pertinent questions regarding the timing and the nature of the exit strategy (Williams 2012). These issues came to the fore in 2013, with vigorous and intensifying debate among policymakers and market participants about the exit strategy from the massive monetary stimulus. This process culminated on 18 December 2013, when the Fed decided at the FOMC meeting (as announced in the public statement) to taper its quantitative easing policy by $10 billion per month, to $75 billion.1 In a recent column, Eichengreen and Gupta (2013) investigated the impact of the tapering talk between April and August 2013, to analyse who was hit and why. They concluded that better fundamentals did not provide insulation. Instead, countries with larger markets experienced more pressure on the exchange rate, foreign reserves, and equity prices.
Tapering ‘news’ and emerging-market financial conditions
In Aizenmann et al. (2014), we investigate the impact of tapering ‘news’ announcements by senior Fed policymakers on financial asset prices in emerging markets. The emerging-market financial asset prices of interest are national stock markets, exchange rates, and credit default swap (CDS) spreads. These reflect a broad spectrum of the potential effects of tapering. We would expect a greater likelihood of tapering, and hence capital outflows from emerging markets, to cause a fall in equity markets, a depreciation of exchange rates, and an increase in CDS spreads (reflecting greater uncertainty and risk in sovereign bond markets).
In terms of Fed ‘news’, we focus on statements from Federal Reserve Chairman Bernanke, Federal Reserve Board Governors, and Federal Reserve Bank Presidents, as well as FOMC statements and minutes. Our presumption is that it is important to differentiate between announcements/statements by the Chairman, as the public face and most important Fed policymaker, and other Fed policymakers (Governors and Presidents). We employ daily data from November 2012 to October 2013. Statements about the likelihood of future tapering, or scaling back the large-scale asset purchase programme, began to emerge in late 2012, marking the beginning of our sample period. However, during this period there were also frequent and forceful statements by Fed officials about the need to continue quantitative easing, so these statements were also included as ‘news’ in our investigation both to address issues of symmetry and to judge market impacts.
The methodology of the paper is a quasi-event study, akin to that of Dooley and Hutchison (2009), tracing the impact of the evolving narrative about the expectation of future tapering, as revealed to the public through the news media, on key emerging-market prices. We use a panel fixed effect framework using daily data with a variety of models to evaluate the impact of ‘news’ on the three assets prices (stock markets, exchange rates, and CDS spreads). However, we do not expect the market responses to tapering ‘news’ to be identical across emerging markets, but rather to depend on their relative strength in international markets. In particular, we exploit the heterogeneity among the emerging markets, evaluating the association between market prices and key characteristics associated with the ‘fragility’ or ‘robustness’ of a country, where these characteristics are defined (below) by their current-account, international reserve, and foreign indebtedness positions.
Markets focused on Bernanke and largely ignored Fed Presidents
We find that emerging-market asset prices responded strongly to tapering statements by Chairman Bernanke, and largely ignored frequent statements in support of tapering by several Fed Presidents (no Governors made public statements favouring tapering during our sample period). This finding is consistent with the power of the Chairman to set and impact the agenda, and with the advantage of more frugal and clear communication.
Countries with stronger fundamentals were more adversely affected
We group emerging markets into those with ‘robust’ fundamentals (11 countries) and those with ‘fragile’ fundamentals (16 countries). Intriguingly, we find that stronger countries, on average, were more adversely exposed to the tapering news than the weaker countries. News of a higher probability of tapering coming from Chairman Bernanke are associated with a large fall in the stock market and an increase in the sovereign spreads of the stronger group, yet had an insignificant impact on spreads and stock markets in the weaker group. The exchange rate depreciated in both groups following tapering news from Chairman Bernanke, yet the depreciations of the stronger group were three times as large as those of the weaker group.
A possible interpretation of these findings is that countries with weaker fundamentals were less exposed to the inflows triggered by quantitative easing, in line with the conjecture that being closer to financial autarky provides deeper insulation from financial news. The flipside is that tapering news had less impact on countries experiencing less inflow of funds in the first instance during the quantitative easing years. Yet, these findings are also consistent with a less sanguine interpretation, reflecting financial markets’ initial inattention to tail risks, overlooking the vulnerability of the weaker emerging markets to the adverse implications of higher future global interest rates. Indeed, in the last quarter of 2013, financial markets refocused attention on the fragile emerging markets, with depressed financial asset prices of the ‘fragile five’ (Brazil, India, Indonesia, South Africa, and Turkey) – a subgroup of the weaker emerging markets.2 While there is no decoupling of emerging markets from US Fed policies, there is systematic heterogeneity in the burden of adjustment. Prices of stronger emerging markets may adjust more swiftly, possibly allowing smoother adjustment of the real economy to the challenges associated with higher future interest rates.
Chairman Bernanke’s tapering news had large effects on emerging markets, resulting in substantial drops in stock market indices and large exchange-rate depreciations. This indicates the expectation of reduced capital inflows and carry-trade activity to emerging markets, with less investment in equity markets. By contrast, numerous and frequently quite vigorous statements in support of tapering by Fed Presidents had little discernable effect on emerging-market financial prices – equities, exchange rates, and CDS spreads – during our sample period. Our analysis also identified strong and systematic heterogeneity of adjustment to Fed tapering (and QE) news across emerging markets. The initial impact of Chairman Bernanke’s tapering news had the largest effect on financial markets in emerging markets that had robust/strong international positions. Tapering news by Fed Presidents had little or no discernable impact on countries’ exchange rates, regardless of whether they were classified as robust/weak in fundamentals, had current-account surpluses or deficits, had high/low international reserves, or had low/high external debt.
It appears that emerging markets with more fragile international positions – especially the ‘fragile five’ – were also affected, over periods extending beyond the initial impact effects of Fed tapering announcements. These results suggest that, in the era of financial globalisation, emerging-market financial markets are not insulated from expected changes in the Fed’s policy stance, although it is sensitive to the heterogeneity among countries (Powell 2013). Understanding the factors accounting for the timing and the intensity of market reactions deserves further exploration. The greater impact of Fed news on the robust emerging markets may be explained by anticipated balance-sheet adjustments, where the size of positions and the liquidity of markets play a role (Eichengreen and Gupta 2014). Alternatively, market attention may shift over time from the short-run adjustment of positions, to the reassessment of the greater adjustment challenges facing the fragile countries in the post-tapering world (Sims 2010). Investigating the possible linkages between the speed of asset-price adjustment and the volatility of future growth patterns is left for future research.
- Chairman Bernanke also projected the programme to wind down steadily through 2014 and conclude by year-end, assuming the economy remains healthy.
- The market’s inattention to tail risks was vividly illustrated by the euro crisis, where the pre-crisis sovereign spreads of Greece, Portugal, and Spain were comparable to that of Germany and other Eurozone core countries (Aizenman et al. 2013).
Aizenman, J, B Mahir, and M Hutchison (2014), “The Transmission of Federal Reserve Tapering News to Emerging Financial Markets”, NBER Working Paper 19980.
Aizenman, J, M Hutchison, and Y Jinjarak (2013), “What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk”, Journal of International Money and Finance, 34(1): 37–59.
Eichengreen, B and P Gupta (2013), “Tapering talk: The impact of expectations of reduced Federal Reserve security purchases on emerging markets”, VoxEU.org, 19 December.
Dooley, M and M Hutchison (2009), “Transmission of the U.S. Subprime Crisis to Emerging Markets: Evidence on the Decoupling-Recoupling Hypothesis”, Journal of International Money and Finance, 28(8): 1331–1349.
Powell, J (2013), “Advanced Economy Monetary Policy and Emerging Market Economies”, Speech at the Federal Reserve Bank of San Francisco 2013 Asia Economic Policy Conference, San Francisco, CA, 4 November.
Sims, C A (2010), “Rational Inattention and Monetary Economics”, in B M Friedman and M Woodford (eds.), Handbook of Monetary Economics, 1(3), Elsevier, Chapter 4: 155–181.
Williams, C J (2012), “Monetary Policy, Money, and Inflation”, FRBSF Economic Letter 2012-21, 9 July.