Fed to meet as taper tantrums rock emerging markets
The yearly World Economic Forum in Davos is done, and top global CEOs are returning home to a week that will see further volatility after last week's emerging market led sell-off.
And there is reason for volatility. As of last December, the U.S. Federal Reserve is currently buying $75 billion in bonds each month, down from the $85 billion it had been buying since September 2012. The Fed's Open Market Committee's rate-setting committee will inform us on Wednesday not only of their latest rate decision, but also on whether we'll see more tapering of U.S. stimulus.
Given the continued U.S. economic recovery, the vast majority of analysts expect the Fed to announce additional tapering to the tune of $10 billion. The Fed, in a sense, used December's slight withdrawal of stimulus to test the market reaction; perhaps because it only was $10 billion, perhaps because it was low-volume-silly-month-December, or perhaps because the market had priced the start of tapering in.
The first tapering move saw markets holding up pretty well, and, in fact, scaling new all-time highs in the weeks after. This time around, the second taper move could be a bit different. Emerging market currencies were dumped last week after the Argentinian Central Bank announced it was relaxing its strict currency controls — a peg used to reposition further given that the FOMC meeting is coming up. The knock-on effect was pretty broad with heavy selling out of other emerging market assets, and Europe and the U.S. saw a bout of profit taking as well. So what could be anticipated this week if the Fed tapers again?
I spoke to Luis Videgaray, the Mexican Finance Minister, and he told me a readjustment in emerging market portfolios has been expected for quite some time as the Fed continues to taper. Some of the readjustment took place last year, and he anticipates there will be more emerging market volatility through 2014.
(Read more: Fed tapering good for Mexico: Finance Minister)
With the Mexican peso weaker by around 3.5 percent against the dollar this month, the Mexican currency has held up pretty well compared to other emerging market currencies. Videgaray told me the key is to ensure liquidity isn't tightening, and until now there have been no signs of this.
Mexico is an open, emerging economy, and Videgaray thinks the country is well-positioned to withstand the current volatility. According to Videgaray, at around 45 percent, Mexican debt-to-gross domestic product ratio is low, it has a small current account deficit (less than 1 percent), and the country's banking sector is seen as well-capitalized.
In the aftermath of the 2008 recession, Mexico was not spared — with the country's GDP contracting by almost 7 percent. Videgaray told me their economy now in on track for 3.9 percent growth this year, and unofficial estimates call for growth of 5 percent in 2015. A large part of this has to do with the recovery of the U.S. given that 80 percent of Mexican exports go north (compared to a figure of just 4 percent of their exports to China). Mexico has also been pushing ahead aggressively with new structural reforms which should serve to keep the country strongly positioned.
(Read more: 'Freaking out' about emerging markets may be wrong)