Investment managers have piled into the developing markets, riding the flow of easy money. However, once the money supply tightens, emerging market exchange traded funds could fall into a recession.
With rising expectations of Fed tightening, the U.S. dollar will strengthen, prices of dollar bonds will decline and dollar funding will reverse, reports Martin Wolf for the Financial Times.
As issued bonds lose value, emerging market borrowers will have to provide more of their domestic currency as collateral, which will squeeze their own cash flows and pressure corporate spending, potentially resulting in a recession in the emerging markets, or a so-called doom loop, according to Wolf.
“In such an event, the doom loop would surely also swallow the stocks of developing markets,” John Rekenthaler, Vice President of Research for Morningstar, said. “They likely would not decline as far, but emerging markets have become so large and so connected with other economies that there would be few places to hide with a stock portfolio.”
The flow of money is not consistent, and the end to easy money in the U.S. could leave the emerging markets without enough when they need it the most. [Yellen’s Help for EM ETFs May be Fleeting]