Emerging Markets. A Time Bomb?
Emerging Markets. A Time Bomb?
The USD bull is in the china shop.
“I hear the narratives that the Fed is printing money...Brrr... and that is going to cause a dollar collapse. I worry that this narrative is very wrong.”
— Raoul Pal, April 25, 2020
As Brent Johnson’s dollar milkshake theory continues to play out, it’s becoming clear the US dollar is slamming into global markets like a wrecking ball.
At significant risk are emerging market sovereigns and companies with high levels of dollar denominated debt obligations.
International businesses, with majority local currency revenues, face higher costs in acquiring dollars for debt service. Profit margins are crushed and lenders face increased credit risk.
As shown in chart 1, the situation is likely to worsen as the dollar could be targeting another 11%+ move higher to the 120 area. For those unaware, this is extreme for a currency. Especially when the currency is the global reserve.
Chart 2 shows the obvious stress on dollar denominated EM bond markets. Yield spreads are widening rapidly as they breakout to new 52 week highs and approach levels seen in prior crisis periods. The chart does suggest further deterioration in EM credit.
The relationship between dollar strength and EM debt has significant geopolitical consequences. If these trends continue, it’s only a matter of time before the next EM debt bomb goes off.
— Brant
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