Global markets are melting down today after heavy losses on US and European markets Friday and across the past week.
The ASX200 and Nikkei are down around 3% while in Shanghai stocks are off 8%. In Hong Kong the Hang Seng is getting hammered and it’s racked up losses of 4% already this morning. The Kospi in Seoul is down 2%, and even the Straits Times in Singapore is under pressure, off 2.6%.
While much of the blame for this latest selling has been placed at the feet of the weaker than expected Chinese flash manufacturing PMI last Friday at least for emerging markets the pressure has been building for months as markets prepared for the beginning of the US Fed’s tightening cycle.
Beijing’s move to devalue its currency, in order to try to rebuild China’s export competitiveness, came at a time when markets were already under acute pressure.
So, while most analysts are careful to say China hasn’t started the currency war, or even joined it, and they are right, it seems the implications for emerging markets and perhaps global markets more broadly are just the same.
Writing last week Konstantinos Venetis from Lombard Street Research said:
Unlike Japan, China may not have started the currency war; but merely raising the threat of joining in should reverberate everywhere. It could spark a reaction beyond the BoJ/ECB, trigger further (market-driven) CNY weakness in response and add momentum to a self-fulfilling process.
He said that the Chinese currency shift “amplifies the EM ‘slow burn’ challenges” the economies face and that “even where fundamentals are relatively benign, pent-up domestic financial imbalances ultimately create dislocations. Capital outflows from EMs have been gathering steam, dragging yields higher.”
Analysts at the ANZ this morning agreed with Konstantinos: “Although we do not believe that China is deliberately engaging in a currency war, the timing of China’s currency reform is not ideal for the rest of the Asian currencies.”
ANZ added “the region is grappling with a trade recession which has seen sharp contractions in export growth across the board, with the exception of Vietnam.”
So the pressure from China is coming at a terrible time in the EM market cycle.
That’s a point picked up on by J.P. Morgan strategists who highlighted this morning that “the rise in global risk aversion is linked in part to the troubling mix of weak growth and elevated private-sector debt in emerging markets.”
So emerging markets have been the cause in the rise in trader and investor risk aversion but are now being pressured by this increase in risk aversion.
That sounds exactly like the type of terrible self-fulfilling negative feedback loop that Societe Generale warned about over the weekend. Just in emerging markets – not markets in general.
J.P. Morgan’s Joseph Lupton warns that things could now get worse because even though “the lessons of the Asian crisis have taught most EM governments that they need strong buffers and prudent domestic financial regulation to avoid a crisis,” they have let private sector debt rise by “about 35%-pts of GDP since 2007 to almost 130%.”
That matters because “there are limits on how public sector resources can be used to support corporates,” Lupton said. Likewise with most of the debt in US dollars and with “EM borrowing totals $4.2 trillion, or about 17% of GDP, when we combine nonfinancial corporates, banks, and other financial entities,” the risk from further currency depreciations around emerging markets and continued capital flight is high.
All of which means that as China grapples with its economy, markets and RMB valuation the pressure is growing on overstretched and over-leveraged emerging markets.
Markets are right to fear China’s path but it’s in emerging markets where the real pressure is continuing to build. In the late 1990’s global finance faced down the Asian Crisis but the 2015 version is spread across Asia, Eastern Europe and South America.
It’s potentially much bigger and much more dangerous. Especially when developed markets themselves are in meltdown.