International Forecaster Weekly

Markets bracing for Fed rate hike impact

Such concern played at least some part in the Fed's decision to avoid raising rates at the last meeting, but a rate hike at next week's meeting now seems a foregone conclusion and the FX markets have already priced them in.

James Corbett | December 9, 2015

The great funny money QE dollar bomb is coming home to roost. US Treasury data shows that of the $750 billion dollars of hot-off-the-press QE play money that flowed out of the US and into speculative emerging economy markets from 2009 to 2014, about $230 billion of that came back in the period from July 2014 to September 2015. That inflow of dollars has likely accelerated since then.

    What's the big idea here? Two words: rate hike. It's no coincidence that it was mid-2014 that the Fed first started hinting at a coming rate hike and that's when the dollars started coming home. The markets have been prepping for the Fed to call in the bets of all the people who have been speculating with cheap US dollars in higher return emerging market investments. Now this unwind is undoing alot of emerging market gains over the past several years with emerging markets struggling with the one-two punch of the looming Fed rate hike and yet more turmoil in the Chinese markets.

    The rate hike is also haunting commodities, which have been inflated by speculation from hedge funds and mutual funds that were driven into the commodities markets in a search for return in a low-rate environment. Now that trade is unwinding and helping (along with the Chinese slowdown) to crash the global commodities index to its lowest level in 13 years.

    As the dollars come home, the dollar index climbs. Although the rise of the dollar this year has not been unbroken, the trend since mid 2014 (when the index hhovered around 80.0) to today (around 98.5) is unmistakable. The big losers here are going to be those emerging economies that are holding the bag on US denominated debt or who have large borrowing needs. Commodity currencies like the Australian dollar and the South African rand stand to be pushed even lower.

    Such concern played at least some part in the Fed's decision to avoid raising rates at the last meeting, but a rate hike at next week's meeting now seems a foregone conclusion and the FX markets have already priced them in. The only surprise now would be if the Fed didn't raise rates next week.

Emerging markets debt sales sink 98pc

    The commodity price slump and the slowdown in China's economy are crippling developing nations' ability to borrow abroad, even as international debt sales from advanced nations remain at a five-year high.

    Issuance by emerging market borrowers slumped to a net $US1.5 billion in the third quarter, a drop of 98 per cent from the second quarter, according to the Bank for International Settlements. That was the biggest downtrend since the 2008 financial crisis and helped to reduce global sales of securities by almost 80 per cent, a BIS report said.

    Emerging market assets tumbled in the third quarter, led by the biggest plunge in commodity prices since 2008 and China's surprise devaluation of the yuan. The average yield on developing-nation corporate bonds posted the biggest increase in four years, stocks lost a combined $US4.2 trillion and a gauge of currencies slid 8.3 per cent against the dollar. Sanctions on Russian entities and political turmoil in Brazil and Turkey also affected sales by companies in those countries.

    "Weak debt-securities issuance in the third quarter can only be partially explained by seasonality," the latest quarterly review from the BIS said. "Growing concerns over emerging market fundamentals, falling commodity prices and rising debt burdens probably played a role. Additionally, an increasing focus on local markets may also have been a factor."

    One side effect of the decline in international debt sales was the emergence of the euro as a borrowing currency. The net issuance of securities in the shared currency by non-financial companies was $US23 billion in the three months through September 30, while dollar-denominated debt accounted for $US22 billion. The main reason for that was a jump in euro-bond offerings from emerging markets, where the share of the currency went up to 62 per cent from 18 per cent in the second quarter.

    Borrowers from advanced economies issued a net $US22 billion in debt, $US100 billion less than in the preceding three months. Still, cumulative figures remained the highest since 2010 because of the increases in the first half of the year. source