As if we didn't have enough to worry about .... the dollar and Emerging Markets

ref :- "Stormy weather from the US is creating headwinds for EM economies" , Markets Insight by John Authers, The Financial Times

see also :- "In a Dollarized World, a Rising Dollar Spells Pain" , Wall St Journal May 9th 2018

Was there ever a time when the world wasn't lurching from one geopolitical crisis to another, never mind having to cope with several at the same time ? We know there must have been, but it seems an awfully long time ago . Of course it would not be entirely realistic to expect everything to be calm everywhere at any particular point in time, but the proliferation of issues with the potential to dramatically affect the world as we know it, and certainly not just in an economic sense, must be a concern to us over-sensitive types.

Some might say that the election of Donald Trump and his belligerent, "America First" approach that is prepared to penalize foes and avowed allies alike is at the heart of it. Others would argue that the President is taking the kind of strong line on a number of issues that previous administrations miserably failed to adopt. Whatever your view, what is indisputable is that Mr Trump's "in your face, do it my way" approach to diplomacy (for want of a better word), world trade and just about anything else has raised the stakes immeasurably.

Until very recently, the safe-haven currencies that would benefit from such stressful conditions would have been those old favourites the Jap Yen , Swissie, and latterly the Euro. No longer, it seems ..... at least, not for now. Geopolitical storms are driving the dollar higher, and it's move is reinforced by a number of other factors : a stumbling growth story in economies outside of the US, notably in the Eurozone where the Euro is also undermined by resurgent political risk in Italy; a sharply rising oil price exacerbated by US sabre-rattling against Iran; the growing chances of a US/China trade war; and most significantly, rising short-term rates in the US and quantitative tightening by the Federal Reserve as it seeks to reduce its balance sheet.

The interest rate differential factor has come back to support the dollar as expectations of the European Central Bank beginning their own rate normalisation process sometime soon, all the rage in the early part of the year, have been postponed. The differential of both 2yr and 10yr US Treasury yields over those of German Bunds hit a fresh high for the Euro era yesterday. With US 10yr yields wavering either side of 3.00%, their is much speculation over whether the breach of that level signals much higher yields in the future --- and if 3.50% was the hawks' target, 4.00% by year-end is now being suggested by one or two of the bond market's heaviest hitters.

A weaker currency can be good news for export-based economies of course, and for the share prices of multinational companies (e.g. FTSE 100), but for emerging markets in particular a significant rise in the value of the dollar spells trouble. Turkey and Argentina are the two countries most in focus on that front, and can provide a good example of just why EMs are viewing what is so far a comparatively small turnaround in the dollar with such alarm.

Take Argentina : As the WSJ points out, Argentina has only modest economic ties with the US, but the Fed's higher rate policy and a stronger dollar is already wreaking havoc (rates up to 40% in an attempt to protect the Peso). You can put that down to the fact that their imports, their exports and MUCH OF THEIR DEBT is denominated in dollars. So, even though just 15% of the country's imports come from the US, 88% of its imports are invoiced in dollars.

Even worse, taken as a whole the Argentinian government owes $98 billion in dollar-denominated debt, and the private sector owes another $68 billion ...... that's roughly one third of GDP. As the peso falls against the US unit, and US rates continue to rise, that debt becomes increasingly difficult (and at some point, impossible) to service ..... hence the desperate hikes in rates and a request for a credit line from the IMF, a widely reviled and politically toxic institution in Argentina after it imposed ultra-stringent austerity measures in exchange for a bail-out during the last (of many) crises to hit Argentina in the early 2000s.

This "Dollarization" of the global economic system has been likened to the spread of the English language, which has been adopted as the "lingua franca" of global commerce, markets and much else. In the case of the dollar, it has happened even while the US share of global output and trade has been diminishing. This can make it a powerful weapon -- the US can isolate Iran just by cutting off its access to the US banking system, for example. But it can mean that all are vulnerable to a rise in the dollar's value .... the slowdown in global GDP this year can be attributed to its appreciation, at least in part.

Mr Authers tells us that professionals might be able to profit from a sector-wide marking down of EM assets. They tend to be priced higher or lower as a block, and the fact that some nations are less exposed to the dollar than others may mean that buying opportunities will present themselves. Good luck to them ..... but for most emerging markets, the combination of lower dollar liquidity, dollar strength, tightening US financial conditions (and rates) and growing geopolitical anxiety is a distinctly unhappy one.

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