Global Markets to Fed: No Rate Hike, the Strong Dollar Is Killing Us
Global markets are puking at the prospect of higher yields in the U.S.
There are many reasons for global markets to melt down, but one that doesn’t get enough attention is the strong dollar. In effect, global markets are telling the Federal Reserve: don’t raise rates–the strong dollar is killing us.
Here’s the dynamic that’s killing emerging markets’ currencies and stocks, the China Story and U.S. corporate profits. In the glory years of a declining U.S. dollar (USD), a vast global carry trade emerged as speculators borrowed money in USD and invested it in high-yield emerging market assets such as stocks, bonds and real estate.
This carry trade was a two-fer: not only were yields much higher in emerging markets, the appreciation of local currencies against the USD provided a currency gain on top of the higher yield.
As the yuan strengthened against the USD, an enormous river of capital flowed into China to take advantage of the revaluation and higher yields in China. How much of this money was borrowed USD is unknown, but it’s estimated that Chinese corporations alone borrowed $1 trillion in USD to profit from higher yields in China.
The virtuous benefits of a weakening USD extended to U.S. corporations, which reap 40% to 50% of their total profits from sales overseas. As the USD weakened, U.S. corporations reaped the currency gains every time they reported overseas sales in USD.
Everybody won with the weakening dollar, except the U.S. consumer, who paid more for imported goods.
But a funny thing happened in late summer 2014–the USD started rising against other currencies–by a lot. Suddenly all those profitable carry trades reversed.
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