Extract from our "EM’s Bad Case of QE Hangover" research paper, published on the 7 January, 2015. Register for a free trial* to access the full paper.
While the dollar is not necessarily under-valued, it is under-owned. The cyclical out-performance of the US economy and the Fed’s normalization stance may help propel the dollar higher, but investors need to be aware of the very large structural short dollar positions in the world, and how this could lead to a sharper and larger dollar appreciation in 2015 than some may have in mind. We are particularly concerned about many of the EM currencies. Over the past decade, EM has accumulated very sizeable dollar liabilities: the governments, corporations, banks and households in EM have dollar liabilities that will become a problem as the dollar rises. Regarding the prospective dollar appreciation, we see the Fed as the ‘spark’ and the cumulative capital flows into EM in the past decade as the large and dry ‘kindling’. At some point, there will likely be ‘breakages’ in some EM economies, which in turn could propel further depreciations in their currencies. What happened to the Russian ruble last year, in our view, should not be an isolated event. While we don’t see a global EM financial crisis, we are likely to see localized financial breakages in some other EM economies this year, triggered by the stronger dollar. One gets a hangover only after (s)he stops drinking. In 2015, EM countries are in high risk of experiencing a bad case of ‘QE hangover.’
The full report contains the following sections:
- Globalisation and capital flows
- QE and portfolio flows: pull versus push
- What high dollar liabilities mean in a strong dollar environment
- The sparks and the kindling
- Currency hedging
- Why China will resist devaluing the CNY
- The Fed and fickle capital
- Bottom line
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