Fed raises interest rates, wreaking havoc on emerging market debt
A perfect storm of economic turmoil and aggressive interest rate hikes by the US Federal Reserve are pushing global investors higher. dollar, pushing up the US currency and depressing others. This is causing problems around the world, but hitting emerging market economies particularly hard.
US Dollar Index (DXY) Daily Chart
Source: commercial view
It will only get worse. Top Fed policymakers are talking tough on interest rates and not backing down when markets suggest they will go ahead with another 75 basis point hike when the Federal Free Market Committee meets September 20 and 21 after a big hike in July.
After signaling a hawkish pivot in his Jackson Hole speech in late August, Fed Chairman Jerome Powell doubled down on the central bank‘s commitment to extracting inflation from the economy with remarks Sept. 8.
“We have to act now, frankly, firmly as we have done,” he told a conference on monetary policy. “My colleagues and I are strongly committed to this project and we will remain there.”
Vice President Lael Brainard said the same a day earlier, at a conference in New York, “We’re here for as long as it takes to bring inflation down.”
The aggressive attitude of the Fed led the dollar to appreciate by nearly 15% against other currencies. The European Central Bank was forced to raise its policy rate by 75 basis points at its September 8 meeting of its board of governors to avoid falling further behind the dollar after falling below parity in August.
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Meanwhile, the war in Ukraine and its impact on energy supply and prices in Europe contributed to market volatility and encouraged investors to seek a safe haven in US currency and liquid US markets.
Among other things, this rise in the dollar’s exchange rate is wreaking havoc on emerging markets because it makes it more expensive to service dollar-denominated debt. Like the ECB, central banks in these countries must try to keep pace with the Fed even as higher interest rates threaten growth and jobs.
$38 billion in releases through July
The Institute of International Finance said recently that outflows from foreign investors in emerging markets totaled $38 billion for the five months ending July. Sri Lanka has defaulted on its debt, while Bangladesh and Pakistan are asking for billions of dollars in aid from the International Monetary Fund.
Source: Visual Capitalist
Bloomberg Economics has calculated that distressed debt in emerging markets has reached a quarter of a trillion dollars, heralding what it calls a cascade of potential defaults. El Salvador, Ghana, Egypt and Tunisia, as well as Pakistan are increasingly vulnerable.
But the list does not end there. Kenya, Argentina, Bahrain, Namibia, Angola and South Africa are also at risk, according to the Bloomberg ranking.
Profit for oil exporters
Oil Middle Eastern exporters and commodity exporters like Brazil are benefiting from a stronger dollar as the US currency is generally used to set prices for these essential commodities. The opposite is true for countries that have to import these raw materials.
The debt of developing countries reached almost 100 trillion dollars at the end of March, and the debt ratio of emerging and developing countries reached 207% in 2020, compared to 119% in 2010 and 56% in 1970.
Many emerging countries that have benefited from investor interest in 2020 due to their higher yields have increased the share of debt denominated in foreign currencies to a quarter of total debt, up from 15% in 2009.
Rising interest rates in the United States have historically been blamed on the Latin American debt crisis in the 1980s, the Mexican peso crisis in the early 1990s, and the Asian financial crisis in the late 1990s. 1990s. A rising dollar raises fuel and food costs while exacerbating the cost of servicing debt.
Developed countries are hardly immune to the impact of a rising dollar and are often just as powerless to do anything about it. But the effect is more on growth and jobs than on escalating debt costs because they have liquid domestic markets for debt.
Learn more in Debt to GDP ratio by country.
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