Turning into January, people suddenly realized the depreciation of emerging markets’ currencies, which has actually been ongoing for over two years.
With the Fed winding down the signature QE in January, money outflow from the emerging markets were accelerated. This is indicated by the drop of the yield of the U. S. 10 year bond, which stands now 2.66% versus over 3% right after the Fed’s announcement of tapering in December last year. Money flow into U. S. caused the drop of the U. S. treasury bond yield.
The exchange rate fluctuation can derail the growth of a number countries in the emerging markets. In defending their currencies, these countries are either raising interest rates or using foreign reserves. High interest rates can choke growth. And foreign reserves in the emerging market countries (except China) are too small to be enough in the context of the QE.
The latest PMI from China suggested further softness in the growth in China. As a result, the currency devalue has extended and spread to some developed countries such as Canada and Australia. For example the Canadian dollar hit multiple low last Friday.
Further complication is added by political movement in Ukraine, Thailand, Egypt and Argentina. In the tightly interconnect world, instability in any of these countries can have significant impact on the economic growth world wide.
I am watching carefully the emerging markets. There might be a wave III of the global financial crisis, and this time it could be the turn of the emerging markets.