See Kevin Muir‘s…
I am far from a currency expert and so reading this article helped put some definition to the hazy thoughts I’ve had about EM and USD’s effects on them.
When the US got themselves into problems in 2008, they flooded the world with liquidity. Instead of saying “no thanks – we have seen this movie before”, emerging markets gulped it down in record amounts in what could be one of the dumbest financial moves in decades.
To me, that is what the whole world did, including the US. Gulped things down. The world is suffering a USD withdrawal since the post-2015 rally was ‘anti-USD’ all the way. The implications for the US may be more nuanced because after all, as Kevin Muir says…
Trump does not want a strong US dollar. He also doesn’t want higher interest rates. If it was up to him, I suspect he would put rates down, print like mad, and institute tons of import duties on foreign goods.
But he does not control monetary policy, so as he pushes down on the fiscal accelerator and also engages in inflationary tariff battles, the Fed’s natural reaction is to tighten even more aggressively. Yet all of this causes the negative feedback loop of a higher-US-dollar-lower-EM-asset-prices to gain steam. Eventually, the Federal Reserve’s withdrawing of monetary stimulus will cause the global economy to tip over into a recession.
So the real question is when does the Fed blink?
That’s the thing; who can quantify the fallout of off the charts post-2008 policy?
There is only so much pain that the global economy can take from tighter Federal Reserve policy. The American dollar is still the world’s reserve currency and it’s clear that the first participant without a place to sit in this game of musical chairs is emerging markets. The next time the music stops it might be an asset class that hits much closer to home and causes Powell & Co. to re-evaluate policy.
There is a mess brewing out there. The first round of musical chairs sees the EMs with no place to sit. Who’s next? Very thought provoking article, Kevin.
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