Chinese Economist Andy Xie shared for CaixinOnline his insights on the consequences of normalization of U.S. interest rates. “As the U.S. continues to normalize interest rates, emerging economies become vulnerable. Brazil and India are at the eye of the storm, but China with its huge property bubble should be wary.”
Global financial markets are adjusting again to the expectation of normalization of U.S. interest rates. The first leg down followed the Fed’s signal for decreasing quantitative easing in June and eased after the Fed talked down its tightening bias. The second leg has begun with recent strong employment statistics for the United States. The magnitude of the adjustment reflects in the rise of the U.S. treasury yield. It rose by about 100 basis points in the first round. The second round could be similar in size.
Emerging markets are most affected by the adjustment. They experience triple whammies in currency declines, interest rates rising and credit spreads expanding. Some emerging markets were shaken hard in the first round. The risk of one or more tumbling over is still significant. Brazil and India are the risk spots among major economies.
Commodity currencies may resume declining. The Australian dollar, Canadian dollar and Brazilian real are risky assets. One difference in the second round is a flattish U.S. dollar. The surge in the U.S. dollar during the first round proved premature. As the interest rate adjusts slowly due to the Fed holding it down through its signaling and QE purchases, the money in emerging markets is not rushing back into the United States. The U.S. dollar may resume its strengthening path when the market believes that the treasury yields have stabilized.
Gold surprises with its strength. The surge in emerging market demand has spooked short sellers. As demand from emerging economies rise above the annual production, gold pricing will shift from the West to the East. Gold prices in future may follow China’s money supply rather than that of the United States.
The current round of adjustment will likely end when the Fed announces the speed of its QE is tapering. The odds are that it would be between US$ 5 billion and US$ 10 billion per month. If it is the lower end, the risk assets would rally and vice versa. Of course, if another emerging market crisis breaks out, the Fed will likely postpone its tapering.
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Dr Andy Xie 謝國忠 is Shanghai-based independent economist specialising in China and Asia. He is currently director of Rosetta Stone Advisors and of China Boqi Environmental Science and Technology.
Dr Xie is one of the few economists who has accurately predicted economic bubbles including the 1997 Asian Financial Crisis and the more recent subprime meltdown in the United States. He joined Morgan Stanley in 1997 and was Managing Director and Head of the firm’s Asia/Pacific economics team until 2006. Prior to that he spent two years with Macquarie Bank in Singapore, where he was an associate director in corporate finance. He also spent five years as an economist with the World Bank.