After the dollar stands at 100, what assets perform best? How much room for US bond yields to rise? Historically, whether the US dollar stands at 100 or the US dollar and US bond yields rise sharply at the same time, it will often bring market turmoil and breed emerging market crises. On April 1, 2022, the president of Sri Lanka declared a state of public emergency. Did Sri Lanka's "Thunderstorm" sound the "alarm" of emptying emerging market assets?
To curb high inflation, the US financial conditions need to be significantly tightened. Judging from the statements of Fed officials, controlling inflation is the top priority of current policy. From the perspective of transmission path, financial conditions are important intermediary indicators: "tightening of policy (expectation) - tightening of financial conditions - decline of demand - easing of inflationary pressure". The central level of US inflation is significantly higher than that from 1990 to 2019, while the financial condition index is still significantly lower than the average value of the same period.
The current exchange rate and interest rate are the main channels for tightening financial conditions. The tightening of financial conditions in the United States is mainly through five channels: the rise of benchmark interest rate (federal funds rate), the rise of long-term US bond interest rate, the appreciation of exchange rate, the decline of stock market and the widening of credit spread. This round of fed interest rate hike lags behind, resulting in the benchmark interest rate is still at a low level. In the stock market, despite the large adjustment of the science and technology growth sector, the energy, national defense and public utilities sectors performed strongly under the circumstances of rising commodity prices, the tug of war between Russia and Ukraine and rising interest rates, which supported us stocks and credit spreads. Therefore, the exchange rate and long-term bond yield may be the main ways to tighten the current financial conditions in the United States.
The US dollar index will stand at 100, commodities will perform best and the stock market will perform mediocrely. Whether from the perspective of interest rate spread, capital flow or the logic of global economy and trade, the inflection point of the US dollar index has not yet arrived, and it will stand at 100 in the second quarter. Historically, during the period when the US dollar index stood at US $100, commodities represented by crude oil performed best; The performance of the stock market was mediocre, especially when the yields of the US dollar and US bonds rose at the same time; The price of gold will be under certain pressure, but there is a logic behind this round of gold price rise to trade the U.S. economic recession, and the price of gold may be more volatile.
US dollar and 10-year US bond yields: they seem to be "friends", but they are "opponents". Logically, the spread advantage brought by the rise in US bond yields should support the US dollar exchange rate. However, in fact, the simultaneous sharp rise of the US dollar index and 10-year US bond yields is not the mainstream. Historically, after the US dollar stands at 100 in the interest rate increase cycle, the US bond yield will continue to rise, but the appreciation range of the US dollar index and the duration above 100 are negatively correlated with the rise range of the 10-year US bond yield. In terms of the effect of tightening financial conditions, there is substitution between the two.
Generally speaking, the impact of a strong dollar on emerging markets can be divided into two different forms: Commodity decline and simultaneous rise. The former is more common. The sharp rise of the US dollar reflects to some extent the global economic slowdown and the sharp decline in commodity prices caused by the decline in demand, which often occurs after a round of commodity bull market, and commodity export-oriented emerging market economies will be greatly impacted; The latter is rare. Under the strong US dollar and the sharp rise of commodity prices, the exchange rate and export income of commodity exporting countries will improve. Small economies that lack resources and are highly dependent on foreign countries (or have a large scale of foreign debt) are often hit hard.
In addition, the "food crisis" brought about by the Russian Ukrainian conflict has made some emerging market economies "worse" in maintaining balance of payments and social stability. From the example of Sri Lanka, we conclude that there are three main ways to impact this time. The first is the deterioration of income caused by geopolitical tensions and repeated epidemics; Second, under the depreciation of exchange rate and the rise of commodity prices, the expenditure burden on foreign debt repayment and imported necessities has increased; Third, the limited supply of raw materials has led to the contraction of China's production, further exacerbating the supply and demand gap and inflationary pressure.
We can draw a "portrait" of vulnerable economies in the current environment. First, the income side is greatly impacted, and the proportion of tourism may not be low; Second, the external debt burden is not small, or the external dependence on energy or food is large; Third, the exposure to Russia, Ukraine and other countries in the import and export industrial chain is not small. Fourth, whether to participate in sanctions against Russia will directly affect the situation of commodity imports.
The strong US dollar and bulk commodities "attack", superimposed with the "plus" of the conflict between Russia and Ukraine, and the allocation value of emerging markets is differentiated. There are still structural allocation opportunities in emerging markets. Under the structural shortage of commodities, the assets of commodity exporting economies still perform well, such as Brazil and South Africa; Beware of economies with a high proportion of service industry and high dependence on foreign energy or food, especially emerging market economies participating in sanctions against Russia, such as Indonesia.
Risk tip: the global epidemic broke out again, the U.S. economy suffered a heavy blow, and the Federal Reserve was forced to suspend interest rate cuts or even return to easing. Significant progress has been made in the conflict between Russia and Ukraine, and Europe and the United States have lifted sanctions against Russia.
