Analysis: Emerging market pain not about to faze U.S.-focused Fed

Sun Jan 26, 2014 7:15pm EST
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By Jonathan Spicer

NEW YORK (Reuters) - The U.S. Federal Reserve, intent on cutting its stimulus again this week, is not about to blink in the face of a brutal selloff of emerging market assets that could yet gain steam in Turkey, Argentina and elsewhere.

Though the central bank's 16-month-old bond-buying program is meant to boost the U.S. economy, in the past it has lifted currencies and stocks in emerging markets that have benefited from a rush of international investment and the resulting lower interest rates.

Now that the Fed intends to wind down the unprecedented policy accommodation by later this year, those markets - especially in countries with large current account deficits - have dropped hard, prompting policy responses late last week from central banks around the world.

But the turmoil would probably have to escalate dramatically and start to hurt the United States for the Fed, focused on domestic improvements in the world's largest economy, to back down from trimming the asset-purchase program known as quantitative easing, or QE.

"When we started QE ... there were many economies and emerging markets and other places that were very critical of our policy. Now that we're trying to stop it, they've been very critical of our policy," Charles Plosser, president of the Philadelphia Fed, said in a January 14 speech in his hometown.

"We are aware of those things," he added. "But the way the Fed thinks about it is, if the monetary policy that we have is the best for the U.S. economy, then that's the policy that we ought to pursue because a strong U.S. economy would be good for most of the rest of the world."

Such reasoning is held throughout the ranks of top Fed policymakers, who are mandated by law to pursue maximum sustainable employment and steady and low inflation in the United States.

Fed officials privately say they try to be as transparent and predictable as possible so that U.S. policy changes do not shock foreign counterparts. And they point out that countries such as Mexico that better manage their budgets are often unscathed by investors searching for risky or safe-haven assets, depending on U.S. policy changes.   Continued...

Turkish lira banknotes are seen in this photo illustration taken in Istanbul January 7, 2014. REUTERS/Murad Sezer