The Emerging Market Contagion Flowchart

There is a striking pattern of regularity how every time the dollar spikes, or sufficient high level, emerging market contagion usually follows.

Yes, of course, "each time is different", and frequently there are idiosyncratic factors but for the most part, the one precipitating factor to turmoil in emerging markets (at first, as it then spreads to developed markets), is a sharp increase in the value of the US dollar.

This is a point we made earlier in "Forget About Turkey: Asia Is The Elephant In The Room", it was also the key point of an article we wrote back in May, titled "Why The Soaring Dollar Will Lead To An "Explosive" Market Repricing."

For reads who missed it the first time, now that emerging markets are once again breaking down - and not just across a few nations but across the globe - it is worth recalling what Deutsche Bank's Aleksandar Kocic said three months ago, namely that the "USD is emerging as the key variable -- it presents a compact summary of the underlying macro risks that could destabilize the current Fed path." In other words, the last thing the Fed wants right now as it accelerates its balance sheet normalization, is a sharp spike in the dollar. And yet, that's precisely what is happening. Kocic explains:

A strong USD corresponds to generally hawkish Fed in an environment where the US is recovering fast while the rest of the globe is still too slow or recessionary, or that the Fed is pushing rates above the neutral and causing excessive tightening of financial conditions and potentially triggering recession. A weak USD path, on the other hand, can materialize either as an inflation or credit (twin deficits) risk, a troubling possibility to which there is no adequate policy response.

For Kocic, the relative strength of the dollar was the exogenous event that could awake markets from their peaceful slumber, resulting in a violent reassessment of monetary conditions as the Fed quietly undoes the biggest monetary experiment in history, or as he puts it, "although unwind of stimulus and Fed exit continue without disrupting the markets, the underlying stability remains local, threatened potentially by the tail risk."

< Prev 1 2 Next >

Sign Up

Get the InvestingChannel
Free e-Letter Today

Learn More

Independent market opinion, analysis and ideas - delivered every business day

Premium market opinions, analysis, and ideas - delivered every business day

Editor's Picks