Adam Posen, president of the Peterson Institute for International Economics, has said investors have underestimated the Federal Reserve's desire to tighten monetary policy, warning it could lead to a stronger dollar and cause another debt crisis in emerging markets.
The head of the currency institute argued investors were wrong to assume US President Donald Trump's fiscal stimulus would have little effect on the economy and that Fed chair Janet Yellen will remain dovish as the US heads towards full employment.
Posen told The Telegraph: "The Fed is going to be far more aggressive than people think. Our view is there will be three to four more rate rises this year."
He also predicts the Fed could move to shrink its $4.5trn balance sheet earlier than expected, leading to a drain on dollar liquidity from the financial system which would have a major shock on the stockmarket, especially in emerging countries.
Data from the Bank for International Settlements suggests a stronger dollar automatically causes banks in Europe and Asia, to shrink their balance sheets which would lead to a slowdown in lending.
With EM debt rising from $16trn to $56trn over the past decade, and over $7.2trn denominated in foreign currency, there is potential for volatility in the markets if the Fed tightens quicker than expected.
Posen said: "We expect the dollar to rise by another 10% to 15%. The concern is this will suck capital out of the more fragile emerging markets and lead to fresh capital outflows from China.
"It may vary country by country but it could be like the 'taper tantrum'. Malaysia and Brazil look vulnerable to us."
For these policies to take shape, Posen has predicted Trump will succeed in getting his tax reforms and fiscal stimulus through Congress, which would cause borrowing to balloon in the US with the deficit rising by as much as 5% of GDP.
After Trump's failure to pass his healthcare reform through Congress last month, Posen said markets have lost faith in the administration but argued this was a mistake.
Meanwhile, he warned the mix of loose fiscal policy and tight monetary policy would cause a loss of trade competitiveness.
"Trade frictions are going to come to a head in two or three years. It is going to be a rerun of the mid-1980s," he told The Telegraph.
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