Economies Must Prepare for Fed Policy Tightening

According to the International Monetary Fund, emerging economies must brace themselves for interest rate hikes in the United States. It warned that faster-than-expected Federal Reserve moves could rattle financial markets, triggering capital outflows and currency depreciation abroad.

In a blog post published on Monday, the IMF predicted that the United States’ robust growth would continue, with inflation likely to moderate later in the year. The global lender expects to release new global economic forecasts.

Foreign demand is offsetting the effect of rising financing costs. Hence, a gradual, well-timed tightening of US monetary policy would have little impact on emerging markets. However, broad-based wage inflation in the United States or sustained supply bottlenecks could cause prices to grow faster than expected. This would fuel expectations for faster inflation and prompting the Federal Reserve to raise interest rates sooner.

Inflation Pressures

The IMF warned that emerging economies should brace themselves for potential bouts of economic turbulence. They cited risks such as faster-than-expected Fed rate hikes and a resurgent pandemic.

St. Louis Fed President James Bullard said this week that the Fed could raise interest rates as early as March, months earlier than expected. The Fed is now in an excellent position to take even more aggressive anti-inflationary measures if necessary. Faster Fed rate increases could jolt financial markets and tighten global economic conditions. These developments may be accompanied by a slowing of US demand, trade, and capital outflows. Moreover, currency depreciation in emerging markets can also affect the demand.

It stated that emerging markets with high public and private debt, foreign exchange exposure, and lower current-account balances had already seen more significant currency movements relative to the US dollar.

According to the fund, emerging markets with higher inflation or weaker institutions should act quickly to allow currencies to depreciate and raise benchmark interest rates. It urged central banks to communicate their policy tightening plans clearly and consistently.