Global financial markets have been extremely volatile in the past six months, many suffering meltdowns.
Crude oil prices have slumped another 50 percent and more than two-thirds of global markets are in bear territory.
Equity benchmarks are down 26 percent on average from their 52-week peak.
Meanwhile, the US market had the worst start in a new year.
And the Hong Kong market has been down in 90 percent of trading days this month as happened in July.
These developments underscore the fragility of global financial markets reminiscent of the 2008 financial crisis the the 2011 eurozone debt crunch.
Emerging markets and commodities bear the brunt of the new financial turmoil.
What’s causing it?
Some say falling oil prices, a weaker yuan, struggling emerging economies and rising risk of global recession are to blame.
However, these are just symptoms, not the root cause of the problem.
The main reason is the end of easy money in the United States.
That has boosted the US dollar which has seen a sustained rally since the Fed tapering in 2014 and the interest rate liftoff late last year.
The strong dollar has weighed on emerging market currencies such as the Chinese yuan.
Commodities, in particular oil, suffered from the strong dollar which in turn exerted more pressure on emerging economies.
The Fed and central banks in Europe and Japan have unleashed more than US$27 trillion in liquidity to emerging markets over past six years.
But as the US continues to tighten credit by lifting interest rates, it will induce more capital to exit emerging markets.
A credit crunch and deleveraging are key triggers for financial market turmoil.
Emerging markets have posted capital inflow as shown in weekly changes in global foreign exchange reserves in the past 12 months.
It started to moderate in August 2014 amid a rapid rise in the US dollar.
In January last year, emerging markets began reporting net capital outflows, which is why their currencies have been falling since the second quarter last year.
Global foreign exchange reserves continue to shrink, a sign capital continues to flow out of emerging markets.
For that reason, global financial markets will remain volatile in the months ahead.
When will all this end?
That depends on when the Fed will end its yield normalization policy or whether it will undertake a fourth round of quantitative easing.
But will it postpone the next rate hike given the state of global stock markets?
The Fed might decide to temporarily ease market sentiment rather than embark on any tangible action.
As long as the US dollar remains strong, capital will continue to flow into to US from emerging markets.
However, the Fed is not likely to loosen monetary policy until there are clear signs of deteriorating growth.
This article appeared in the Hong Kong Economic Journal on Jan. 28.
Translation by Julie Zhu
[Chinese version 中文版]
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