Financial markets are fretting about the structure of the quantitative easing that the US Federal Reserve is soon expected to announce.
As capital flows into emerging markets continue to surge, investors say that expectations of further stimulus from the Fed to help revive a flagging US economy are already priced in.
This has been reflected in the weakening of the US dollar, which the central bank expects to reignite growth. Earlier this week the greenback plumbed a 15-year low against the Japanese Yen, and a record low against the Swiss franc.
It helped buoy equity markets, as the S&P 500 closing Tuesday at its highest level since May.
Jonathan Mann, a director in emerging market debt at Foreign & Colonial Investment Management in London said: “Quantitative easing is now priced in, the only questions are how much and which assets.”
Steve Cain, a macro hedge fund manager at Henderson Global Investors, said the Fed has a handful of options. “Will it be incremental or a block of balance sheet expansion, or perhaps more scarily a target rate for two- to five-year government securities of say 25 bps?” he asked.
The latter option would mean the Fed targets a certain interest rate and then buys Treasuries until rates in the marketplace reach that level.
Rates on Treasuries currently range between 45 bps and 105 bps. The latter option would cut rates for many American borrowers, ranging from households to corporates. It was a strategy outlined by Ben Bernanke in 2002, before he became Fed chairman, in a speech that addressed ways of avoiding deflation.
In stark contrast, inflation is more of a problem for emerging markets as the search for yield has pushed investors into “risk-on” mode and inflows continue to surge. Earlier this week the Institute of International Finance raised its estimates for capital inflows into emerging economies to $825 billion from a prediction this April of $709 billion.
Hedge fund manager Crispin Odey, who manage $5 billion at Odey Asset Management, contends that the rise in emerging market currencies is merely the next step in the process of ironing out global imbalances.
“What is billed as a currency war is in fact the natural outcome,” Odey said. “The extent to which it happens quickly also means that they won’t have to endure a most monstrous bubble.”
Imbalances have been reflected particularly in the continued surge in emerging market currencies. This week the Thai baht held at a 13-year high while the Australian dollar soared to a record.
Governments have refrained so far from imposing capital controls, in part because of the stigma left over from the 1997 financial crisis. Instead central banks throughout Asia, which include Thailand, Malaysia, Korea and Taiwan, have all been trying actively to stem the appreciation of their currencies. It is estimated that Asian central banks spent up to $16 billion last week whilst Brazil doubled a tax on foreign bond purchases.
Investors anticipate that the governments will soon move to impose capital controls, particularly as they contend with vociferous complaints from exporters.