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Fed Comments Weigh on EM Stocks, Currencies

Fed Chair Janet Yellen’s remarks send mixed signals for emerging markets
The past five years of stagnant trade growth reflects fundamental changes to the global economy that will drive continued stagnation in  global trade over the next decade and beyond.The past five years of stagnant trade growth reflects fundamental changes to the global economy that will drive continued stagnation in  global trade over the next decade and beyond.

Emerging stocks and currencies came under pressure on Monday, weighed down by the dollar romping to its strongest level in nearly seven months and long-dated US bond yields climbing higher following comments by Federal Reserve Chair Janet Yellen, Reuters reported.

The Federal Reserve may need to run a "high-pressure economy" to reverse damage from the 2008-2009 crisis that depressed output, sidelined workers, and risks becoming a permanent scar, Yellen said on Friday in a broad review of where the recovery may still fall short.

MSCI's emerging market benchmark weakened 0.5%, with bourses across Asia chalking up solid losses while stocks in South Africa, Turkey and Russia fell by around 0.5%.

Currencies weakened against the dollar and bond yields clambered higher in many emerging economies after Yellen said on Friday the Fed may need to run a "high-pressure" economy to reverse damage from the 2008-2009 global financial crisis that depressed output.

Her remarks raised speculation that Yellen may be willing to let inflation run above the bank's 2% target and prefer to keep an easy monetary policy stance for a long time.

"She said she would allow the US economy to run a bit further than normal in terms of monetary policy, which would be positive for EM, but they are also signaling they want to try to steepen the yield curve, which could be negative for EM bond markets—so it's a mixed signal for emerging markets," said Jakob Christensen, head of EM research at Danske Bank.

Adding to the pressure was US data out on Friday, showing a rebound in retail sales in September, pointing to solid demand that reinforces expectations of a Fed interest rate hike in December.

Currencies Suffer

Currencies bore much of the pain. Turkey's lira weakened by 0.4% in its seventh day in the red, yet stayed shy of the record low it had hit last week.

Russia's ruble matched that fall, shrugging off a decision by ratings agency Fitch on Friday to raise its outlook on Russia's sovereign debt to "stable" from "negative".

South Africa's rand also weakened for the third day, but losses were less pronounced after the deputy president was joined by business leaders showing support for Finance Minister Pravin Gordhan, who faces fraud charges.

The Chinese yuan slumped to its weakest since September 2010 on a weak central bank guidance rate, but selling was tempered by caution over possible intervention by authorities to halt further depreciation.

The picture was similar across central and eastern Europe. Hungary's forint weakened 0.2% against the euro while Poland's zloty almost matched that fall after hitting its weakest level in the month earlier in the day.

Investors are also awaiting a raft of global economic data this week, including US industrial production on Monday, US consumer prices on Tuesday and Chinese third-quarter gross domestic product on Wednesday.

Peak Trade

Since 2011, global trade growth has been stagnant. With protectionist sentiment intensifying in the US and Europe, and with China appearing to pivot away from export-oriented growth strategies, a hypothesis informally known as ‘peak trade’ has become increasingly popular.

According to this view, the past five years of stagnant trade growth is not temporary, but instead reflects fundamental changes to the global economy that will drive continued stagnation in global trade over the next decade and beyond.

This view has important implications for global asset markets in at least two ways.

First, trade is often seen as an engine of global growth, and the sputtering of this engine over the past five years (and the idea that it has permanently stalled) has been widely interpreted as an important reason to be sceptical of global growth in the long run—a view that is baked into the very low levels of long-dated bond yields in advanced economies.

Second, peak trade implies long-run pessimism for the assets of economies particularly dependent on trade, including many emerging markets.

 

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