What side effects will U.S. rate hike trigger? Emerging markets, Europe will suffer - Analysts

Today central bankers, analysts and economists are gathering in Jackson Hole for their annual meeting. Two questions are on the top of the agenda: Will the Fed hike interest rates in September, and will the global economy sink if it does?

For months, traders, economists and various market players have been wondering whether Fed Chairwoman Janet Yellen will raise rates in September or wait until 2016. Ms. Yellen has decided not to appear at the Jackson Hole meeting this year, possibly because she's already sick of this endless question.

But she's partly to blame for that. For weeks, she went back and forth on the rate liftoff question. Sometimes she said the time was approaching, while after that she highlighted further economic recovery was needed.

Recently, the unemployment rate in the U.S. has been approaching low levels - at which workers' bargaining position could get strong enough to induce economy-wide wage increases - which are usually a crucial factor in driving inflation.

Since the beginning of the global financial crisis 2008, the Fed kept its "federal funds rate" (the rate at which the Fed lends to banks) at the lowest levels in history - between 0.0 and 0.25%. With interest rates offered to savers by commercial banks set lower than the inflation rate, wealthy people have complained about having their savings devalued, or even robbed of, as a side effect.

On the other hand, financial markets participants with the ability to borrow on margin have become cheap-money addicts. Besides, the central bank's policy of large-scale bond-buying (QE) between 2009 and October 2014, under previous Fed Chairman Ben Bernanke poured $3.5 trillion into the accounts of institutional investors. This avalanche of money had to be invested somewhere, and so QE's net result was a sustained equities boom, Deutsche Welle comments.

Risks for emerging markets

Two years ago, when Bernanke hinted at a nearing end of QE, emerging-market currencies got under a heavy pressure. Among the hardest-hit countries were Brazil, South Africa, Turkey, Indonesia and India, which since have been called the "fragile five."

Commerzbank analyst Lutz Karpowitz said in a report: "What made them especially vulnerable was their high trade deficits, which became more expensive to finance in 2013 because of slightly higher US interest rates and a stronger US dollar."

Since then, India's trade deficit has substantially decreased. Indonesia's one has shrunk somewhat too, while others have remained vulnerable.

For many analysts, Brazil is a concern. Over there, production and consumption are both in decline, and inflation is hitting double-digit levels. Russia has been extremely weakened with the rouble plunging due to the lower prices of oil. In Turkey, political uncertainty is putting the Turkish lira under pressure. The circle of unstable emerging economies is growing.

China deserves a special mention. The economic uncertainty connected to internal debt crisis in the second largest economy is threatening to infect its trading partners. The global economy is expanding less than expected, Chinese exports are declining, and Shanghai equity prices are have just started recovering after a grinding 23% drop.

The Chinese slowdown is affecting its partners: Dutch wealth management company NN Investment estimated that almost a trillion dollars has left emerging markets over the past 15 months.

Undoubtedly, Chinese or Brazilian problems have nothing to do with the Fed rate hike, but it would nevertheless intensify negative trends in EMs - because it could cause a great deal more money to be pulled out. This could trigger "something like the Asian crisis at the end of the 1990s, when countries would have to impose capital controls and protectionist measures" to prevent the collapse of their economies, chief economist at Assenagon Group Martin Hüfner said in an interview with DW.

Developed and emerging markets

Risks for Europe

Europe will not be hurt too much. Quite the opposite: the strong greenback has helped euro-denominated exports more competitive globally. However, Europe could feel the side effect from EMs.

Today the world has hardly any tools left in hand with which to face a crisis: interest rates are already at near-zero levels; stimulus packages like the ones launched in 2008 aren't likely either, since many national governments are already groaning under high debt loads.

The Fed is now considering the global environment which could soon include the EM rout and thinks on postponing the hike. 

Yesterday, William Dudley, president of the New York Federal Reserve Bank, added fuel to the speculation that rates won’t lift off in September. At a news conference in New York Dudley said, “From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago.”

However, the strong data released earlier is quite convincing that the Fed may shrug off the turmoil overseas.

Data released yesterday showed that U.S. core capital goods orders showed the biggest increase since June last year.

Investors will now await the U.S. second quarter GDP later in the day, as well as a weekly report on initial jobless claims and data on pending home sales for July.

But above all, there is Jackson Hole in focus, with its questions and awaited answers.