Emerging Markets Insight

Economic Policy in an environment
of growing uncertainty

Oct 31, 2018

Emerging market highlights

  • Recent market volatility and growing policy uncertainty in the US has forced monetary authorities in Emerging Economies to turn more hawkish.
  • The global economic environment continues to be robust, although negative tail risks have gone up.

Market overview

It’s been three years since the Fed started tightening monetary policy in 2015. Since then they have also introduced the strategy to start reducing the size of their balance sheet. The European Central Bank and the Bank of Japan are many steps behind the Fed in their own path towards policy normalization.

Financial markets have had plenty of time to adjust to the changing environment of monetary policy around the world. Emerging economies still are at an earlier stage of the expansionary cycle than the US and thus have more space to maneuver in a rising volatility environment.

But tighter financial conditions have created some difficulties for emerging economies, especially those with significant external vulnerabilities such as Argentina, Turkey and more recently India. Despite the strong fundamentals of EM there is a possibility that external risks could propagate to other countries that show similar vulnerabilities like South Africa and Indonesia. Our sentiment measurements of monetary policy in EM shows that authorities have been forced to turn more restrictive in order to anchor medium term expectations (see graph below).

Although EM has shown resiliency and adequate policy response in the current volatile market environment, the most significant challenge they face is the rising economic policy uncertainty mostly in the developed world, particularly the US.

We used our quantitative techniques to process 5,000 daily broker reports and explore the text content to quantify uncertainty of economic policy in the main economies. As the graph below shows, the perception of analysts is that uncertainty of economic policy appears to be the highest in the US, Canada and the European Monetary Union (see graph below).

Higher levels of policy uncertainty may be forcing some emerging economies to have a tighter monetary policy than they would otherwise prefer. Perhaps governments around the world should consider a predictable and transparent approach to economic policy making, just like the Fed has successfully been doing for the past few years.

Rising Policy Uncertainty

North American Trade Risks

Source: BlackRock, Sept 2018.

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