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Fed: end of "dovishness" in late 2014? / Monetary tightning will not lead to EM crisis

Europe improves: risk of governments taking their foot off the pedal

(PresseBox) (Frankfurt a.M., ) .
Fed Tapering

"With tapering already considered inevitable, the markets' attention has turned progressively to "forward guidance." The Fed has stressed that it is in no hurry to raise overnight rates, and that it will wait to see the unemployment rate fall to about 6.5% before doing so. In testimony before Congress in June, Fed Chairman Ben Bernanke even suggested that a fall in joblessness to 6.5% would "not automatically result in an increase in the federal funds rate target" if inflation continues to remain as tame as it has been. Yet futures markets recently brought forward their expectations for a first hike in short-term rates somewhat (from early 2015 to late 2014), and FOMC statements will be closely parsed for even the slightest indication that the Fed is shifting from its current "dovishness.""

Emerging Markets:

"External debt as a percentage of GDP has declined substantially since the 1990s in many emerging markets. Floating exchange rates and substantial reserves mean today's emerging-market economies generally are far better placed to defend themselves. And a repeat of the substantial and unforeseen global monetary tightening by the Fed in the mid-1990s that led to the Mexican crisis looks to us highly unlikely. While some individual countries face severe challenges because of their dependency on commodities and yawning trade deficits, others, like China, have begun to see some improvement in their fortunes. South Korea's economy recorded its strongest quarterly growth in more than two years for the three months through to 30 June. Brazil-like India, seen as vulnerable to currency volatility because of its large current account deficit-actually overshot consensus growth expectations with an annualised growth rate of 3.3% in the second quarter. Australia, often seen as a bellwether for the global economy, also defied expectations by growing at an annualised rate of 2.6% in the second quarter."

China: "PMI data for the country's manufacturing sector hit a 16-year high in August. China's external trade has also progressed strongly in the past two months. The authorities have already proved they are acutely aware of the risks posed by "shadow banking" and-having learned lessons from the US financial crisis-appear well-placed to deal with the consequences of any sudden credit crunch. In addition, we believe the Chinese government has the fiscal strength to absorb losses and stimulate the economy further, should the need arise."

Europe, positive signs:

"While some emerging markets seem to be floundering, the economic recovery in the eurozone and in Europe as a whole appears to be gaining some modest momentum. Optimism that the eurozone is turning the corner saw regional equity markets generally outperform their equivalents in the US, UK and Japan during volatile trading in August. And while bond yields in emerging markets have been rising and currencies falling, perceptions that the European debt crisis is easing have meant that Spanish and Italian government bond yields have held steady."


Europe still trails the US in terms of growth, and the more sceptical observers point out that eurozone GDP growth of 0.3% in the second quarter (after -0.2% in the first) suggests stabilization in activity rather than a true recovery. Despite some decline in financial pressures and an upturn in consumer and business confidence, the outlook for a solid and lasting recovery in the real economy remains fragile, these sceptics argue. PMI numbers have improved, but there is still considerable capacity underutilization in European industry. There is also a risk that further economic improvements and the lessening of tensions regarding European sovereign debt, alongside voter fatigue with austerity, could cause financially fragile European governments in general to take their foot off the pedal when it comes to pushing through needed reforms. There were few expectations that general elections in Germany would lead to a radical change in how Europe's leading economy interacts with the rest of Europe. Any newly (re)elected Chancellor will, with his/her European partners, have to deal with a familiar list of issues that includes very high private and public debt levels (and not just in the so-called "peripheral" countries of southern Europe), an incomplete overhaul of Europe's ailing banking system, and the likelihood of further financial aid and debt write-offs for Greece.