Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

More on 2014 as 1994 redux

Last week, I wrote a blog post on how 2014 may witness the same withdrawal of capital flows from emerging markets as was seen when the US Fed tightened interest rates in 1994. Over the weekend (India time), the Fed published a speech by Chairman Ben Bernanke which spells out the issues with surprising bluntness. The key points as I see it in this speech are:

  • Long term US rates are likely to rise: “Overall, then, we anticipate that long-term rates will rise as the recovery progresses and expected short-term real rates and term premiums return to more normal levels. The precise timing and pace of the increase will depend importantly on how economic conditions develop, however, and is subject to considerable two-sided uncertainty. ”
  • A repeat of 1994 cannot be ruled out: “… in 1994, 10-year Treasury yields rose about 220 basis points over the course of a year … A rise of more than 200 basis points in a year is at the upper end of what is implied by the mean paths and uncertainty measures shown in charts 4 and 5, but these measures still admit a substantial probability of higher–and lower–paths”. In fact, that last sentence is even more scary. Bernanke is saying that it could in fact be even worse than in 1994!
  • The Fed is concerned about financial stability risks arising from a large rise in interest rates: “First, we have greatly increased our macroprudential oversight … Second, … we are using regulatory and supervisory tools to help ensure that financial institutions are sufficiently resilient to weather losses and periods of market turmoil … Third, … greater clarity concerning the likely course of the federal funds rate … should … reduce the risk that market misperceptions … would lead to unnecessary interest rate volatility.”

Bernanke is clearly warning US financial institutions to prepare for the coming bond market sell-off. It is not Bernanke’s job to warn emerging markets, but to those emerging market policy makers who read the speech, the message is loud and clear – it is time for serious preparation.


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