Threat of contagion in emerging markets deepens commodity risk
So far, commodity markets appear to have ignored the potential for emerging-market contagion. Where there have been losses, they’ve been more closely tied to other concerns.
When Thailand devalued its currency two decades ago, few in global commodity markets took note. Within a year, the crisis morphed into an emerging-market rout that eviscerated the price of everything from crude oil to copper. Fast forward to today and Turkey is presenting a similar challenge. The lira plunged to a record low against the dollar this month, taking local stocks and bonds with it. Commodity markets have failed to react, with even gold unmoved by the chaos. Traders are focused more on Iranian sanctions, South American mine strikes and drought damage to crops, all of which point to higher, not lower, raw-material prices.
Now, the lira’s plunge is spreading to other developing economies, with broad currency and equity weakness in markets such as South Africa, India and Indonesia. That pain is coming at a time when those nations were already adjusting to higher borrowing costs after the U.S. Federal Reserve raised interest rates in June, for the seventh time since 2015.
“The problem is that the world is addicted to a super-low interest rate environment,” said Richard Fullarton, the London-based founder of Matilda Capital Management Ltd., a commodity focused hedge fund. “The transition to higher rates will be more painful than expected. We should expect lower rates of growth during a transition phase.”
Add to the mix the trade war between the U.S. and China, and the potential for a significant slowdown in emerging-market growth next year is more substantial. The International Monetary Fund warned in a report last month that “the balance of risks has shifted further to the downside.” Since then, trade wars have intensified, and the currencies of many emerging countries have weakened.
While in previous crises - from the Latin American debt crisis of the 1980s to the Southeast Asian crisis of 1997 - the US could be relied on to be the firefighter, this time it’s been something of a fire starter.
On Friday, after slapping new steel and aluminum tariffs on Turkey, President Donald Trump took to Twitter to highlight the trouble in Ankara, saying the lira was sliding “rapidly downward against our very strong Dollar!!”. The currency plunged to a record low.
The Federal Reserve raised rates in June to the highest in a decade and the debt market anticipates further increases this year.
So far, commodity markets appear to have ignored the potential for emerging-market contagion. Where there have been losses, they’ve been more closely tied to other concerns. Copper lost about 15% in two months because of worries that China’s growth will slow, while U.S. soybean prices dropped about 20% over the same period as Washington and Beijing issued reciprocal trade tariffs.
The Bloomberg Commodity Index fell 5% this year, compared with a 31% drop in 1998 and 37% plunge in 2008.
“The risks around Turkey’s economic crisis are not trivial but, at this moment, contagion risks are limited,” said Amrita Sen, chief oil analyst at Energy Aspects Ltd. in London.
Compared with two decades ago, emerging markets now have the potential to wreak far more havoc in commodity markets. Look at oil: the International Energy Agency expects industrialized nations to account for just one-sixth of growth in consumption next year, compared with 50% in 1999. It’s a similar trend in other key commodities, from copper to coal to soybeans.
“For now, we have made no changes to our underlying economic and oil demand assumptions, but we are mindful that demand growth could cool down later this year and into 2019,” the Paris-based IEA warned last week.
Weaker economic growth really shouldn’t be that surprising. The U.S. economy has expanded for nine consecutive years, the second-longest period of growth in the National Bureau of Economic Research’s data going back to the 1850s. Some developing economies such as China haven’t experienced a recession in decades.
Costlier raw materials - the dollar price of crude more than doubled from its low in 2016 - won’t help. In nations such as Turkey, South Africa, India and Indonesia the cost of oil in local currencies is close to or even above the levels reached in 2008, when Brent touched an all-time high in London. Worse, many developing nations reduced or removed energy subsidies over the past five years, leaving consumers fully exposed to international prices.
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