The “taper tantrum” still looms large in the minds of policymakers in developing economies. The disorderly sell-off, which was triggered by hints from the US Federal Reserve in May 2013 that it was considering scaling back its quantitative easing programme, hit emerging markets hard, particularly those that were heavily reliant on inflows of foreign capital. Last Wednesday, the Fed gave developing economies ample reason to fret about the risk of another tantrum when it surprised financial markets by shortening the timeline for when it expects to start increasing interest rates. Having previously been sanguine about the surge in inflation, the Fed said there was a possibility that price pressures may have a longer-lasting impact, and that it expected to begin raising rates in 2023, a year earlier than originally forecast. The reaction in markets was relatively muted, considering the significance of the Fed’s hawkish tilt. Yet, in one crucial area, the impact was dramatic. The US dollar, which has been under severe strain due to the Fed’s ultra-dovish stance since the eruption of the Covid-19 pandemic, rebounded sharply. The dollar index, a gauge of the greenback’s performance against a basket of other major currencies, rose 2.1 per cent last week, its best week in over a year and one of its strongest weekly performances in the past five years. In a report published on June 18, JPMorgan argued that “the Fed’s unexpected hawkish pivot … has the makings of a bullish watershed for the [dollar]”. If so, and if the policy shift is as significant as some investors claim, emerging-market assets are in for a rough ride. However, a more hawkish Fed, and a stronger dollar in particular, could be a boon to China. Over the past several months, Beijing has struggled to maintain stability in markets. This is partly because of a surge in speculative inflows of foreign capital, driven by China’s swift recovery from the pandemic, its higher rates of return and the stability of its government bond market. Policymakers have resorted to increasingly forceful measures to take the heat out of asset prices. One area of concern has been the fierce rally in the yuan, which at the end of last month hit a three-year high against the dollar. Although a strong currency is helping underpin domestic demand by making imports of overseas raw materials cheaper, the pace of the appreciation has alarmed Beijing when the economy is slowing. This month, the People’s Bank of China forced banks to hold more foreign currencies in reserve in an effort to temper the yuan rally. China has been even more forceful in its efforts to rein in speculation in red-hot commodity markets , ordering state-owned enterprises to curb their exposure to foreign markets and releasing state reserves of industrial metals to dampen prices. The Fed-induced rebound in the dollar is helping Beijing tame financial risks. While the yuan is down 1.5 per cent against the dollar this month, the Bloomberg Commodity Index has lost 2.9 per cent since June 10. If the Fed’s hawkish shift is sustained, and markets believe America’s central bank is less concerned about withdrawing stimulus, some of the foreign money that has been gushing into Chinese assets could flow back to the US as government bond yields – in particular real yields – rise, increasing the appeal of dollar-denominated assets. China better prepared for US Fed policy moves this time around, analysts say While many other emerging markets are under pressure to raise rates and are worried about destabilising outflows of capital as the Fed prepares to unwind stimulus, China has already begun to tighten policy and has been more concerned about managing an influx of foreign capital. Still, a hawkish Fed is no panacea for excessive exuberance in China’s markets. For starters, the liquidity sloshing around the financial system is overwhelmingly domestic, trapped by capital controls that impose severe restrictions on overseas investments. Managing foreign inflows more effectively requires a swifter liberalisation of China’s capital account which is fraught with risks . Second, and just as importantly, it is not clear whether the Fed policy shift is as hawkish as it appears, casting doubt on the sustainability of the dollar rally. In the last several days, several Fed policymakers, including governor Jerome Powell, have played down the threat posed by the surge in inflation, insisting they will be patient in waiting to raise rates. Not only does this give the impression of a central bank that is worried about the risk of another tantrum, it shows the Fed is increasingly divided over the timing and conditions of a rise in borrowing costs. Uncertainty over the conduct of US monetary policy is a recipe for further volatility in global markets. The last thing China needs is external forces that make its markets more turbulent, instead of helping steady them. A resolutely hawkish Fed could take some of the heat out of China’s markets. However, a vacillating Fed is in nobody’s interest. Nicholas Spiro is a partner at Lauressa Advisory