US News

Brainard signals Fed concern on emerging market vulnerabilities

The second-in-command at the US central bank said the Federal Reserve was paying attention to tumult in global markets caused by monetary policy tightening, but insisted rates must keep rising to combat inflation all the same.

Lael Brainard, vice-chair, acknowledged that rate rises across the world — a movement largely led by the Fed — would affect highly indebted emerging markets, with rapidly rising rates potentially causing instability.

“As monetary policy tightens globally to combat high inflation, it is important to consider how cross-border spillovers and spillbacks might interact with financial vulnerabilities,” Brainard said on Friday. She added that the Fed was “attentive” to such vulnerabilities, which “could be exacerbated by the advent of additional adverse shocks”.

The Fed is considering whether to carry out what would be its fourth consecutive 0.75 percentage point rate rise at its next policy meeting in November. More generally, the round of interest rate rises and bond sell-offs by central banks across the world has resulted in a surge in borrowing costs and retreat from risky assets such as equities.

Emerging market stocks have tumbled 29 per cent in dollar terms this year, leaving them on track for the biggest drop since the global financial crisis in 2008, according to a broad MSCI gauge. The index provider’s index of currencies of developing economies is down 8.4 per cent so far this year.

Global financial markets have also whipsawed this week due to turmoil in the UK related to the government’s tax cut and borrowing plan, as well as broader concerns about how aggressively the Fed will need to stamp out the worst inflation problem in four decades.

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Brainard told a conference hosted jointly by the Fed and its New York branch that “the global environment of high inflation and rising interest rates highlights the importance of paying attention to financial stability considerations for monetary policy”.

The IMF and other multilateral organisations have repeatedly warned about the acute risks confronting emerging and developing economies, many of which are saddled with large stocks of debt, whose servicing costs have ballooned as global interest rates have risen.

Brainard said concerns about debt sustainability could propel “deleveraging dynamics” — such as the sell-off of assets in countries with high sovereign or corporate debt levels.

But she underscored the Fed’s commitment to “avoiding pulling back prematurely” from higher interest rates.

In August, the Fed’s preferred inflation gauge — the core personal consumption expenditures price index — increased 0.6 per cent and is now running at an annual pace of 4.9 per cent. This compares with its 2 per cent inflation target.

Brainard warned that the risk of additional inflationary shocks “cannot be ruled out” and emphasised the Fed met regularly with its counterparts across the world to “take into account cross-border spillovers and financial vulnerabilities in our respective forecasts, risk scenarios and policy deliberation”.

The Fed vice-chair reiterated that “at some point” it would need to consider if its monetary tightening went too far. She argued that the effects of the policy would take time to filter through the economy and that uncertainty about how far rates needed to rise was high.

Brainard highlighted the impact of tighter US monetary policy on demand for foreign products — which means that those countries’ economies are reined in not just by interest rate rises at home but also by reduced US appetite for their goods.

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“The same is true in reverse: tightening in large jurisdictions abroad amplifies US tightening by damping foreign demand for US products,” she added.