The ecosystem of financial markets is likely to go through fundamental changes after Donald Trump officially takes over the helm. That might trigger another wave of financial market turmoil in the future.
The Federal Reserve had launched several rounds of quantitative easing after the 2008 financial crisis, pushing interest rates to ultra-low levels for quite a long time. But these measures have had limited impact on boosting the economy.
Instead of relying on monetary stimulus, Trump has pledged during his election campaign to adopt tax cuts and expand government spending on infrastructure.
The Republican Party’s domination of the US Senate and House should allow for a smooth implementation of Trump’s policies.
No wonder the financial markets appear to have started pricing in such a policy shift.
Trump’s stated policies could spur inflation and would require the issuance of large amounts of bonds.
Apparently spurred by expectations of Trump’s policies, 10-year Treasury bond yields shot to their highest level this year.
Rising bond yields and expectations of higher interest rates pushed the dollar index above the 100 level.
Strong gains of the greenback between mid-2014 and early 2015 triggered a price collapse of various commodities led by oil and metals.
That hurt numerous emerging economies, particularly those depending heavily on exports of such resources.
A stronger dollar also heightened concerns over emerging countries with large US-dollar-denominated debts, further causing capital to take flight and their equity markets to sink.
A similar picture seems to shaping up again.
The JPMorgan emerging markets currency index and JPMorgan Asia Currency Index have tumbled recently. The latter even touched the lowest level since March 2009, a sign that capital is fleeing emerging markets again amid the strong dollar.
Meanwhile, emerging market credit has expanded extremely fast after the financial crisis. Credit in the non-financial sector surged 156 percent since the end of 2008, far above the 17 percent growth in developed economies.
Emerging economies have a total debt of over US$16 trillion maturing next year, of which up to 44 percent is US dollar debt.
So if the US dollar continues to strengthen, it would exert mounting pressure on emerging markets.
This article appeared in the Hong Kong Economic Journal on Nov.17.
Translation by Julie Zhu
[Chinese version 中文版]
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