Why Volatility Matters (Third of a Series)

In the classic 1962 film, “Lawrence of Arabia,” two British officers watch the unfolding chaos as Arab tribes vie for control of Damascus. Eager to keep events from spiraling out of control, the colonel pleads with his commanding officer, “We can’t just do nothing.” The general, savvy to the political reality, replies calmly, “Why not? It’s usually best.”

Doing nothing neatly sums up the position the Fed took at the close of their much-awaited September meeting last week. Some kind of hike seemed a foregone conclusion only weeks ago. Janet Yellen and her board elected instead to focus less on the US economy and more on the risk of slower growth in China and emerging markets.

While some economists expected the no-hike scenario, few predicted the associated dovish commentary that accompanied it. Clearly policymakers have been spooked by what they see in global markets and how that might affect growth and inflation at home.

What concerns many observers now is that by choosing to focus on the situation abroad, the Fed has essentially become hostage to forces out of its purview and control. What is the likelihood EM economies will stabilize or improve over the next few months? Does this reluctance to take a step towards US interest rate normalization foster continued uncertainty? And does the resulting volatility thus become a self-fulfilling prophecy by sending a message to global economies that things are worse than they appear?