Ben Bernanke’s signaling of a possible tapering of the $85 billion-a-month stimulus the Fed has been providing the U.S. economy has had the disruptive first and second-order effects one associates with a tsunami.
The tremors in the currency markets as the dollar becomes stronger have been felt for some time now. Now there is a tidal wave of overseas stock markets plunging as investors realize that the U.S. is the place to be.
While the emerging markets have been the worst hit, the developed economies haven’t escaped the upheaval caused by Bernanke’s June 19 communication. The euro and GBP both lost 1 percent on the day, and the yen 1.5 percent. The Dollar Index that tracks the dollar against six other major currencies rose 1 percent, indicating the dollar’s consistent gains.
While the Fed has made it clear that it will not hike interest rates till unemployment falls to 6.5 percent from current levels of 7.6 percent, consumer confidence indices are at a five year high in the U.S., and home prices are continuing to rise. This could lead to a further strengthening of the dollar and investment in U.S. securities becoming more attractive.
This is good news for companies that sell primarily in the U.S. market like an AT&T Inc. (NYSE:T), Southwest Airlines Co. (NYSE:LUV), or a The Kroger Co. (NYSE:KR). Unlike MNCs who will see the value of their foreign income and assets fall due to a rise in the dollar, such companies remain unaffected. In the case of Southwest Airlines Co. (NYSE:LUV), ironically a strong dollar allows it to expand its operations internationally (it already flies to Mexico and the Caribbean). Of late, the dollar’s rise has been accompanied by the commodity markets bottoming out. The lower input costs help a food retailer like The Kroger Co. (NYSE:KR) push even more aggressively on its strategy of displacing branded items with store brands—the latter now accounting for 24 percent of all sales. AT&T Inc. (NYSE:T) potentially can make 4 cents on every dollar of debt that it uses to retire dividend paying stock in the current scenario of a rising dollar combined with low interest rates.
Emerging Markets or Submerging Markets?
Emerging markets from Poland and Turkey in Europe, Thailand and the Philippines in Asia, to South Africa and Mexico, have all seen their currencies fall between 1 to 4 percent against the dollar in the last week.
The stock markets, the engines of growth in these rapidly growing economies, have not taken the shock well. While the Brazilian index went down by 2.5 percent, Mexico’s stock market lost 2 percent. Asian markets, with their high foreign exposure, were worst hit—the Philippines’ market lost 4.6 percent, Indonesia’s 3.5 percent, while Thailand was the worst performer with a 5 percent fall.
Money pulled out from these markets by foreign investors is going into instruments like 10-year U.S. Treasury bonds whose yields have been consistently rising since May 2013.
India— From Bad to Worse
India’s case illustrates the vulnerability of emerging markets. Until recently India was a poster child for emerging markets, clocking 8-9 percent growth rates and being talked about in the same breath as China. While China’s economy is also slowing down, India’s suffered several self-inflicted wounds due to policy paralysis and a high current account deficit.