US interest rates are soon to rise; threat to recovering economies is real — IMF Chief Economist

Gita Gopinath, chief economist of the International Monetary Fund (IMF), has warned that recovering economies will be threatened by a ‘taper tantrum’ — meaning that interest rates rise in the US and investment is diverted there from other destinations — a rate rise is now expected this year.

Emerging markets, in particular, cannot afford a repeat of the “taper tantrum” market disruption that occurred in 2013 as the US central bank prepares to withdraw monetary stimulus, she points out.

“They (emerging markets) are getting hit in many different ways, which is why they just cannot afford a situation where you have some sort of a tantrum of financial markets originating from the major central banks,” Gopinath said Sunday in an interview with the Financial Times.

Gopinath’s comments came after US Federal Reserve Chair Jerome Powell said on Friday that the Fed could start tapering asset purchases this year if the US economy evolved broadly as anticipated.

While highlighting the economic pressures on low and middle-income countries, Gopinath warned of the potential fallout should inflation become a more pernicious issue in the United States and force a sudden move to tighten monetary policy.

“We are concerned about a scenario where you would have inflation come up much higher than expected, and that would require a much quicker normalization of monetary policy in the US,” she said, adding central bankers needed to provide “super clear communication” on a frequent basis about their policy path forward.

Emerging market assets sold off significantly amid a sudden push higher in US Treasury yields in 2013, when then-Fed Chairman Ben Bernanke first mentioned the idea of tapering the Fed’s pace of asset purchases.

“Emerging markets remain vulnerable to tapering by the Federal Reserve, as less support for the US economy could tighten financial conditions across the globe,” Jonathan Fortun, economist at the Institute of International Finance, said in a note earlier this month.

“Despite the bleak outlook, we believe that contagion risk is less severe than during the EM (emerging market) sell-off in 2018 or during the 2013 taper tantrum,” Fortun said, noting the importance of emerging market policy credibility will be paramount in the months ahead, especially if interest rates rise.

The Fed has pledged to keep its benchmark interest rate unchanged at the record-low level of near zero, while continuing its asset purchase program at least at the current pace of $120 billion per month until “substantial further progress” has been made on employment and inflation.