Why the Fed credibility crisis will hit emerging markets harder

As political pressure on the US Federal Reserve intensifies in Washington, the reverberations are rippling across the globe. Gregory Peters, co-chief investment officer of fixed income at PGIM, has noted that bringing political pressure to bear on the Fed is an “own goal” – a self-inflicted shock that erodes confidence and is unlikely to deliver lower borrowing costs for the US. This reassessment – marked by quiet “sell America” trades – is beginning to surface. The damage extends far beyond Washington. It creates long-term risks to inflation trajectories and could push the global financial system towards greater fragmentation and inefficiency, leaving emerging markets and developing economies in Asia, Latin America and Africa most exposed. To be sure, these consequences stem from multiple factors, but doubts over the Fed’s independence are undoubtedly one of the key drivers. The most revealing signal of this reassessment is visible in official reserve behaviour. Central banks and global investors have increased their exposure to traditional safe havens, with gold emerging as a primary beneficiary. By the third quarter of 2025, gold accounted for close to 30 per cent of global official reserves. As the world’s second-largest reserve asset, its share advantage over the euro has widened. Yet the renewed accumulation of gold also carries macroeconomic trade-offs. Unlike reserve currencies, gold does not provide liquidity backstops or support crisis-era funding mechanisms. When more global savings flow into non-yielding assets, the international financial system becomes less flexible to shocks over time. A widespread flight to safety may undermine the efficiency of capital allocation and weaken the resilience of the global financial system. These effects weigh heavily on emerging markets. Constrained by shallow financial markets and lower gold shares in official reserves, emerging markets have experienced a dual shift towards gold for private investors and central banks. The share of gold in the reserves of emerging markets and developing economies’ central banks rose sharply from 6.9 per cent in late 2021 to 11.4 per cent by the end of the first quarter of 2025. In Asia, this trend is particularly pronounced in China and India, which together accounted for 53 per cent of global demand for gold bars and coins in the first half of 2025. For economies with relatively low per capita capital stocks and substantial investment gaps in manufacturing, infrastructure and technology, such shifts raise questions about opportunity costs. In theory, persistent capital flows into non-interest-bearing assets will worsen capital misallocation and, if accumulated to a sufficient extent, may exert a dampening effect on long-term growth engines. Renewed demand has increasingly spread to other precious metals. The International Monetary Fund highlights persistent inflationary risk: a 1 per cent rise in copper prices lifts core inflation by roughly 0.02 percentage points after a year, and by around 0.3 percentage points after two years. For countries reliant on metal imports like India, or manufacturing hubs like Vietnam, the impact is amplified even further. The dollar’s weakness reflects rising US risk premiums rather than a steady, orderly depreciation, amplifying uncertainty in emerging market financial systems. The Indian rupee and Indonesian rupiah both traded near historic lows in 2025. Furthermore, global investors may question the Fed’s ability to underpin global financial stability in future crises. Such a shift in expectations will push up emerging market risk spreads. Some Latin American or African countries with high external debt ratios are likely to bear the brunt. Gold’s poor liquidity relative to the dollar may also constrain central banks’ capacity in dealing with crises. This is particularly true for African countries, with their limited reserve levels and a heavy reliance on US dollar funding. The erosion of confidence in the Fed’s independence therefore risks producing what might best be described as a “multi-lose” outcome – one in which neither the US nor the rest of the world emerges unscathed. What is striking is how unusual the global reaction has been. Central bankers and former Fed officials have rarely intervened so publicly in defence of a sitting Fed chair. For decades, the Fed has stood as both a benchmark and an anchor for professionalism among central banks of emerging markets. During periods of systemic stress – from the 2008 global financial crisis to the recent pandemic – it was the Fed’s institutional standing that enabled rapid coordination and confidence-building across borders. As confidence in the US monetary stewardship falters, the spillovers ripple across the globe, through exchange rates, capital flows and risk premiums, and the cost of adjustments falls more heavily on emerging markets with fewer policy buffers. The adage still holds: when the Fed sneezes, much of the world catches a cold. None of this means that the Fed’s independence should equate to insulation from scrutiny. Independence without accountability breeds complacency; accountability without independence invites political capture. For emerging markets, which have little say in Fed decisions, it is a matter of global economic fairness. Strengthening oversight of the Fed’s monetary policy deliberations and liquidity operations would not only bolster confidence in US economic stewardship but also help sustain the fragile foundations of the global economy and financial stability. The Fed’s credibility is more than an American strategic asset – it is a global public good that underpins global trade, investment and growth. In an era defined by zero-sum politics and fragmentation, this is one of the few areas where enlightened self-interest and global stability still clearly align.