The effect of US quantitative easing on emerging markets.

23/12/2010

The US Federal Reserve (Fed) recently announced that it will pump $600 billion into the US economy by the end of June 2011 through quantitative easing. We’ll consider the possible effect this will have on emerging markets.

Why are they doing this?

Consumer spending in the US has been slow to recover from the economic crisis. To try to encourage consumers to spend, the Fed reduced interest rates to close to zero.

This hasn’t had the desired effect, so the Fed is injecting money into the economy by buying bonds, typically from the government, but sometimes from companies (this is quantitative easing). It’s hoped this’ll filter down to consumers, giving them more money to spend.

How will this affect the global emerging markets around the world?

The term ‘emerging market’ can loosely be defined as a country that is undergoing rapid economic growth with household incomes rising towards the levels in the richer developed world. This is not a universally accepted definition. Fortunately, data providers, such as FTSE and Dow Jones, have their own criteria to determine whether a country is an emerging market.

Brian Coulton, Emerging Markets Strategist at Legal & General explains how this money may end up in these emerging markets.

‘As consumer spending is currently subdued in the US as households look to pay down their debts, we expect some of the extra money may be saved and then invested outside the US , including into emerging markets around the world like China, India or Brazil.’

Is that good news?

Investment into emerging markets is good news. With the money working its way into those economies, it is likely to free up money at the banks. This should in turn lead to greater lending both to consumers and companies, which will boost spending and demand. These are all positive factors that could increase share prices in these countries.

But there is a concern – inflation. As explained above, greater lending should result in an increase in demand. So, applying the basic economic principle of supply and demand, prices would be expected to rise. As prices increase, so will inflation.

Brian adds, ‘These price increases could be further fuelled by the increase in prices of global commodities that we’re currently witnessing, for example wheat. This will further contribute to the possibility that inflation will increase to unsustainable levels in emerging markets.’

What does that mean?

It means that the quantitative easing measures being used by the Fed are potentially a good thing for emerging markets. The key to success will be how emerging market governments look to control both the investment into their countries and the resulting impact on inflation.

Want to invest in emerging markets?

To find out more about investing in emerging markets, visit our Global Emerging Markets Fund page.

Please remember that investing in funds like this should be considered a medium to long-term investment of at least five years. Both capital and income values may fall as well as rise and are not guaranteed. You may get back less than you invest.