The meltdown in emerging markets has just begun
An aluminium can factory in San Carlos, California. Donald Trump's tariffs and retaliation by major nations will broaden to consumer goods, meaning higher inflation and lower consumer purchasing power to the West and a disaster scenario for emerging markets.
Dubai - We take a look at some of the factors that will hasten it
I had argued that emerging markets faced a financial meltdown in successive columns, most recently since my visit to the sceptered isle in mid-May. Unfortunately, the macro logic of my conviction has not changed even as I see an emerging market meltdown is happening in real-time. Why?
One, the US Dollar Index bottomed at 88 three months ago. It is now 95. King Dollar has returned with a vengeance, a scenario that is a disaster for emerging market currencies from the Brazil real to the Indian rupee, the Turkish lira to the Pakistani rupee, the Argentine peso to the Mexican peso. There are four major reasons for the US dollar's resurgence. The political centre was annihilated in Italy by a far-left-far-right populist coalition, Chancellor Merkel faces the twilight of her political career in Germany, eurozone industrial production data has slumped while the ECB dare not shrink its balance sheet in September.
Two, the Volatility Index was 25 in March as financial markets considered the threat of Trump's EU steel and aluminium tariffs. Yet the tariff tension has escalated into a full-scale global trade war with the EU, Canada and Mexico but the Volatility Index is just above 13 despite the recent turmoil in global equities. A global trade war is simply not priced into volatility or asset valuations despite the ursine fireworks on Wall Street last week. This means downside risk in emerging markets will continue to rise this summer.
Three, I cannot forget that the 2013 and 2015-to-early-2016 emerging markets meltdowns were both preceded by a money market squeeze in Shanghai and a mini-devaluation of the Chinese yuan that sent shock waves across the world. The Middle Kingdom was hunky-dory three months ago, as Wall Street bought the "Xi Jingping put" on Chinese growth, financial stability and commodities demand with a vengeance. This was the reason bank strategists dissed the woes of the Turkish lira or the Argentine peso as "idiosyncratic". To be polite, this is bull manure. Contagion in emerging markets is now unmistakable. Even the Indian rupee trades at 68.70 as I write, a telltale sign of debt distress and fear in emerging markets Shanghai plunged by four per cent after the Dragon Boat holiday. If Trump really threatens to impose tariffs on $200 billion of Chinese goods, Beijing could well retaliate by reducing its purchase of US Treasuries or even a major Chinese devaluation. This will be the July 1997 (Thai baht triggers the Asian flu) or 2001 moment (Argentine default, Turkish banking crisis) moment for Asia and emerging markets. The MSCI emerging markets index has now declined for six successive days as I write, a bearish scenario omen. The impact on the semiconductor business on a US-Chinese trade war is an argument to short Taiwan. King Dollar, higher US rates and a liquidity squeeze in the Chinese property markets means short Hong Kong. Lower Chinese growth and commodity appetite is Armageddon for Southeast Asian equity markets.
Four, the political scene in emerging markets is toxic. A far-left firebrand Lopez Obrador will be the next president of Mexico in the July elections, thanks to Mexican disgust with Trump's Gringolandia. There is no real hope for the centre-right President Michel Temer in the Brazilian election in October. President Erdogan has threatened global ratings agencies and foreign banks once his AKP wins reelection in Turkey. The BJP has faced setbacks in several Indian states (notably Karnataka) and the pro-business PML-N in Pakistan reels from the disqualification of Nawaz Sharif.
Five, Trump's tariffs and retaliation by the EU, Canada, China and Mexico will broaden to consumer goods. This means higher inflation and lower consumer purchasing power to the West, a disaster scenario for emerging markets. Note that more than 50 per cent of Turkish manufactured exports are destined for the EU, where stagflation means another major lira crisis. Turkey's $250 billion consumer banking time bomb has only one endgame - a deep recession.
Six, the Powell Fed is forced by Trump's fiscal stimulus to raise interest rates and shrink its balance sheet. This means a trillion-dollar hit to the global liquidity pump at the precise moment US funding needs accelerates to at least $600 billion. Property is the kiss of death in a debt deflation credit cycle. Goodbye, goldilocks!
The writer is a global equities strategist and fund manager. He can be contacted at email@example.com.