NIBC Research: Turmoil in emerging markets raises a few questions
Chart of the Week
The Chart of the Week shows exports of Brazil and South Korea. It was particularly the devaluation of the yuan on 11 August that increased anxiety among market participants over the economic outlook of China. Although the Chinese government’s projection of 7% real GDP growth for this year seems so out of touch with reality that no sane person believes it, still a big unknown is how big the fall-out from the bursting of the China bubble is going to be. There are various channels through which the downturn in China may affect other economies, but the most straightforward one is via a downward effect on world trade. South Korea, Taiwan and Brazil have already produced export data over August. Indeed, the results are quite disappointing. South Korean and Taiwanese exports both tumbled by 14% compared to August 2014. Considering their dependence on exports to China there can be little doubt that Chinese demand has slumped. Brazil, which is a large exporter of commodities and oil has suffered a 24% (y-o-y) downturn in exports last month.
– We doubt that the soothing statements made by both Chinese and other officials about the Chinese economy at this weekend’s G20 meeting will be fully embraced by market participants as this crisis is as much about the Chinese economic downturn as it is about central banks and/or authorities losing control.
– The question is if China and other emerging market countries will be under that much economic and financial pressure in the near future that the liquidation of foreign exchange reserves will gather pace. August figures for Chinese foreign exchange reserves published this morning revealed that China liquidated $90bn of reserves last month, a clearly stronger pace than seen this year till July (averaged around $25bn per month). Clearly, as the speed of currency depreciation picks up and inflationary pressures pick up alongside with it, the temptation for countries to start using reserves to intervene and to stem the slide in their currencies must be increasing markedly.
– Also the West includes some regions or countries that are dependent on energy or commodity exports. As such, we have seen the currencies of Canada, Australia and Norway under downward pressure this year. Moreover, last week the news came in that Canada is actually in economic recession as it published the second consecutive decline in its real GDP level for Q2. Canadian annual GDP growth is now markedly diverging from the US, which raises the question if this divergence will be sustained?
– We still think that the Fed will hike rates in the near term. However, we also suspect that the Fed will be on hold for some time after a first rate hike. Nonetheless, as the Federal Reserve will likely continue to have a tightening bias, it also means that the markets are on their own in absorbing the shocks from China and other emerging markets in the near future or should be looking to other central banks for help.