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Fed volatility is emerging markets’ ‘poison’: Analyst

The notion that markets will return to 'normal' this year is pure fiction, one analyst told CNBC on Thursday, noting weaker emerging markets are still vulnerable to volatility stemming from the Federal Reserve's monetary policy.

Emerging markets came back into the spotlight in recent weeks, after steep drops in the currencies of countries like Argentina, Turkey, Brazil and South Africa - all of which have current account deficits - reminded investors how vulnerable they can be to worries over a reduction in the Fed's asset-purchase program.

(Read more: Stand by: EM turmoil sparks credit crunch fears)

Axel Merk, chief investment officer of Merk Investments, told CNBC that Fed members have been acting confused, and a lack of clarity in policy direction would continue to hurt the more vulnerable emerging markets this year.

"Fed policy is going to be volatile and the key implication from that is that it's poison for emerging markets, because the volatility is bad for markets with little liquidity," said Merk.

Emerging markets - which have been one of the biggest beneficiaries of quantitative easing - were hit particularly hard last year when talk of 'tapering' first started to panic investors, and countries with higher current account deficits saw vicious selloffs as a result.

Janet Yellen, Chair of the Federal Reserve.
Getty Images
Janet Yellen, Chair of the Federal Reserve.

The Fed eventually began its taper in December when it reduced asset purchases by $10 billion, a move it repeated at its January meeting. Although many analysts now believe the end of quantitative easing (QE) has been priced in, other commentators, including Philadelphia Fed President Charlie Plosser, suggested Fed policy could still catch people off guard.

(Read more: Emerging markets—Is it time to bottom fish?)

In a speech made in Rochester, New York on Wednesday, Plosser said the current levels of tapering could prove insufficient if the economy keeps growing at its current pace, and said the Fed may be forced to scale back asset purchases faster, by mid-2014.

Merk told CNBC he was concerned Fed policy makers did not have a strong handle on things.

"The Fed is transparently confused, they don't have a clue what's going on and the reason they don't have a clue is because they have taken away their gauges," he said, referring to how QE has distorted the bond markets, making it difficult to analyze inflation expectations.

Furthermore, the market hasn't yet priced in the new Fed chair Janet Yellen's dovish viewpoint, said Merk, and could be surprised when she makes a U-turn in both the bank's communication style and policy, though he believes it will be a while before any policy reversal does happen.

(Read more: Emerging markets rout a reality check for Davos elite)

All of this will have consequences for emerging markets, he said.

"It's not going to work.... so the emerging markets, in particular Brazil and South Africa - they'll be jolted around, maybe Turkey as well," he said. "We will continue to be in an environment where there are heavy handed choices [made] by policy makers and the market is going to react. This notion that we go back to normal as many folks say out there isn't going to happen anytime soon."

However, other analysts told CNBC that there has been confusion over how reliant emerging markets have been on the Fed's flow of easy money.

(Read more: Did the Fed sink the emerging markets?)

"I am confounded by this assumption that the emerging markets have somehow been major beneficiaries of QE and loose monetary policies. I just do not buy into this at all," said Jim Walker, founder & CEO of Asianomics, who told CNBC on Wednesday that he believed the emerging market correction was largely over.

"The main beneficiaries of the Fed's QE program have been U.S. equities and partly U.S. housing market," he added.

Walker said the main reason economies like Argentina and Turkey have suffered such brutal selloffs this year, was due to individual structural problems that should have already been addressed, rather than a direct impact of Fed monetary policy.

Tim Condon, head of Research for Asia at ING Financial Markets, said the market has misidentified the cause of the recent bout of emerging market stress.

"We attribute the stress in emerging markets to growth worries, not G3 monetary tightening worries," said

"The 10-year U.S. Treasury yield is a principal determinant of emerging market creditworthiness but its re-pricing for the taper occurred in May-August of last year," he added.

By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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