Amid many unknowns, EM assets will remain strained

Subject

Emerging markets under strain from dollar rally.

Significance

The US Bureau of Labor Statistics reported on January 6 that average hourly earnings grew at the fastest pace since 2009 in December -- a further fillip to the ‘trumpflation trade’ that has gripped financial markets since the victory of Donald Trump in the US presidential election. Expectations of further Fed rate increases have driven the dollar index and the ten-year Treasury bond yield higher, straining emerging market (EM) assets. EM mutual equity funds have suffered a wave of uninterrupted outflows since Trump’s victory. The Mexican peso and the Turkish lira have plumbed record lows against the dollar.

Impacts

• Many EMs are preparing to sell dollar-denominated debt in anticipation of higher borrowing costs, including Argentina, Brazil and Nigeria.
• Speculative bets against US Treasury bonds have risen to a record high amid expectations of higher US inflation and further rate hikes.
• The stock of negative-yielding government bonds stands at 10.8 trillion dollars, fuelling demand for higher-yielding securities.
• In April, the US Treasury’s next Foreign Exchange Report could label China a currency manipulator though the criteria would need to change.