12 December 2018
US dollar strength, amid expectations of a Fed rate hike, has led to fund outflow from emerging markets recently. Photo: CNSA
US dollar strength, amid expectations of a Fed rate hike, has led to fund outflow from emerging markets recently. Photo: CNSA

Will emerging markets face another financial turmoil?

Bond yields and US dollar have both seen sharp gains since Donald Trump won the US presidential election earlier this month.

There are worries that emerging markets may witness fresh financial turmoil, like what we saw happen between mid-2015 and early 2016.

Capital inflow into emerging markets has already reversed, according to data from the Institute of International Finance. And the outflow is expected to accelerate next month.

The US dollar index is likely to test new high of 107 next year. That would exert more pressure on emerging markets, including China. 

Meanwhile, there is a question surrounding the commodity market: is it headed for a bull or bear cycle?

Commodity prices slumped last year, which badly hurt some resource-rich nations. However, many commodities performed very well in recent months, and the industrial metals price index even touched a year high.

Data from the US Commodity Futures Trading Commission shows that speculative commodity positions fell to a 13-week low in mid-November but were still far above the level seen during last year’s financial turmoil.

It seems speculators are not that bearish on commodity prices.

That reflects easing pressures on global economic growth. Expectations are on the rise for stronger inflation, given Trump’s pledge to boost infrastructure spending.

Goldman Sachs recently outlined a positive view on commodities, making its first such call in four years, and suggested that investors should increase their exposure to the sector next year.

Interestingly, dollar strength is widely expected to sustain next year.

Commodities, most of which are priced in the US currency, and the greenback have historically had an inverse relationship for the most part. But now, what we could be witnessing is commodity prices and the dollar rising at the same time.

Since 1999, commodity price index and the US dollar index saw two periods of positive correlation — the first between 1999 and the first half of 2001, and the second between second half of 2005 and first half of 2006.

During the two periods, global inflation was picking up and the Fed was in the middle of an accelerated rate hike cycle. That means the Fed is very likely to raise interest rates at faster-than-expected pace if both dollar and commodity prices edge up.

Will emerging markets undergo financial turmoil again? The possibility is fairly high if the dollar rises and commodity prices plunge.

But what if both the dollar and commodities rally again next year?

Rebounding commodity prices will mitigate economic pressures for some nations. However, that does not necessarily reduce the chance of a possible market crash.

Emerging markets saw credit expand at a stunning pace in the last couple of years. These nations would see about US$7 trillion in debt maturing next year, representing 44 percent of their total maturing debt.

In that case, a spike in interest rates would accelerate capital outflow, which may lead to another market meltdown.

If that happens, what will be the impact on the US market?

At present, global investors are directing money out of the emerging markets and back into the US. This has enabled Wall Street to post solid gains.

But can we expect the same to continue going forward?

Capital inflow may help US equities for a while, but if there is financial turmoil in the emerging markets, it is bound to eventually be a drag on even the US market.

This article appeared in the Hong Kong Economic Journal on Nov. 24

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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