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Comment: Fed moves spell trouble for emerging markets

By Digital Look

Date: Thursday 17 Sep 2015

Comment: Fed moves spell trouble for emerging markets

(ShareCast News) - The 'will they, won't they' dance around the Fed goes on, writes IG analyst Chris Beauchamp. Even if there is no hike in September, the ramifications of the gradual shift to tightening will still be felt, especially in emerging markets.
Over the past few years, emerging markets have built up a huge pile of debt, around $7.5trn.

As a result, they are now acutely vulnerable, even to the gradual and slow tightening cycle that Janet Yellen seems to have planned.

At present, markets only expect rates to reach 1.4% over the next two years, while the Fed itself is aiming for a rate above 3%.

This, according to ratings agency Fitch, suggests a dangerous imbalance; any outcome that is closer to the Fed's own expectations rather than the market's risks further disruption in vulnerable economies around the globe.

Even Fed policymakers themselves have voiced concerns, saying that a rate rise and gradual tightening could create a feedback loop that hits the US, as export markets go into recession.

The China tantrum of the past two months is just one manifestation of this.

Given these concerns, it would be easy to see how the dollar rally of 2014/15 continues to wane. The broader dollar index has been unable to move beyond the 98 level all summer, as we can see on the chart below.

Chart: US dollar index, 2014 - 2015

If the Fed does the sensible thing and stays away from easing in September, and also in December, accompanied by soothing language in its statement, then I expect the US dollar to continue to wane.

Indeed, even if they do raise rates I do not see why the US dollar should stage a recovery -the emerging market turmoil that would follow would hit the US, weakening the economy and perhaps prompting the Fed to cut rates and even consider more QE.

We may see an equity recovery in Q4 if the Fed avoids raising rates, with the liquidity provided by the ECB and the Bank of Japan acting as an additional incentive for investors to move back into riskier assets.

Yet even here, the muted performance of stock markets in 2015 suggests that there needs to be a big game-changer to put us on an upward path.

Whatever happens, emerging markets look vulnerable, and the most prudent course might be to stick with developed markets, at least until the great unwinding of debt in emerging economies is done.

Chris Beauchamp is senior market analyst at IG

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