MacroscopeHow a hawkish US Federal Reserve could help China tame domestic risks

While emerging markets have good reason to fear a taper tantrum as the Fed discusses raising rates, the resulting dollar rebound could be a boon to China

Not only could it help rein in red-hot commodity markets, it could also divert speculative capital gushing into Chinese assets back to the US

3-MIN READ3-MIN

Federal Reserve Board chairman Jerome Powell testifies on the US central bank’s response to the coronavirus pandemic during a House Oversight and Reform Select Subcommittee hearing on Capitol Hill in Washington on June 22. Photo: AFP

Published: 3:30am, 25 Jun 2021Updated: 4:22am, 25 Jun 2021

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]”.