The latest minutes of the US Federal Reserve meeting signalled a "patient" approach to interest rate hikes as policymakers continued to weigh various headwinds to growth.
While the central bankers are still debating how long their newly adopted "patient" stance on US rates policy will last, global markets have turned volatile as they digested the Fed's latest dose on interest rates outlook.
The global markets keep a track of Fed developments as it impacts foreign flows, dollar value versus other currencies, bond yields and global economic stability.
Currencies
Since the currency of the US is considered to be the benchmark in the forex market, a rise in the Fed rate will push up the value of the greenback against the currencies of other countries.
For emerging economies, currencies are most affected when there is a change in the US Fed rates.
In case of a Fed hike, the US dollar appreciates in value and puts pressure on the balance sheets of banks, firms, and households that borrow in dollars and spend in other currencies, while also putting pressure on exchange rate regimes linked to the dollar that do business in other currencies.
Foreign flows
The emerging markets had benefited hugely from the quantitative easing done by the Fed and other central banks in the developed countries and now that liquidity is being tightened, which could lead to capital outflows.
Emerging markets are already reeling under the impact of this normalisation of the Fed’s balance sheet and the repatriation of funds to the US.
The countries that run current account deficits, such as India, have seen their currencies depreciate sharply.
Government borrowing
When interest rates are low, emerging markets tend to borrow in the US dollar, which helps boost their economic growth.
In case of a rate hike, money gets routed back to the US, which leads to higher borrowing costs in the developed countries.
Financial stability
Rising rates in the US would force emerging economies to increase their own rates, in order to protect their currencies, which would threaten financial stability.
