Li Xunlei, Chief Economist of Zhongtai Securities

  In early May, the Federal Reserve decided to raise the target rate of the federal funds by 0.5 percentage points, and decided to shrink the balance sheet from June.

This means that the Fed's monetary policy has tightened across the board.

Tighter money usually means slower economic growth, as interest rates rise and the willingness to invest and spend decreases.

  The Fed's new round of interest rate hike-shrinking cycle is different from the capital market situation of the US economy in the previous round. This round of the US economy has a greater risk of a hard landing and the stock market bubble is even bigger.

From historical data

,

the Fed's tightening of currency will have an impact on emerging economies

  In terms of total GDP, among the top ten countries in the world, only China and India belong to emerging economies, and the other eight countries belong to developed economies with per capita GDP exceeding 30,000 US dollars.

Since the end of World War II, the global influence of emerging economies other than China has not increased significantly in general. Except for the rise of the Asian Tigers, the status of other emerging economies has not improved much.

  From the perspective of the structure of the global industrial chain, most of the developed economies are at the high end of the industrial chain, China is at the middle and low end, and other emerging economies are mostly at the low end.

This determines that most emerging economies are at a disadvantage in the global division of labor. Their economies are not only small, but also have not formed their own sound industrial systems.

Either as a supplier of upstream resource products, they are greatly affected by the global economic cycle;

  Since these emerging economies are highly dependent on developed countries, the loosening or tightening of US monetary policy will have a great impact on these countries.

For example, in the three periods of 1986-1989, 1995-1998 and 2014-2015, the growth rate of countries other than the United States declined significantly, especially the emerging economies excluding China, while the economic growth rate of the United States was relatively high and more stable.

  Further analysis, it can be found that the three economic weakenings of emerging economies all occurred when the United States tightened its currency:

  1986-1989: The U.S. federal funds target rate rose from below 6% in 1986 to over 9.8% in 1989; the average GDP growth rate of emerging economies excluding China significantly lagged behind the global economic growth rate.

  1995-1998: The U.S. federal funds target rate rose from 3% in 1994 to 5.2% in 1998; the average GDP growth rate of emerging economies excluding China dropped from 3.07% to 1.2%, while the U.S. GDP growth rate increased .

  2014-2016: Quantitative easing (QE) in the United States began to exit, the federal funds target rate rose from 0.25% to 0.75%, and the US dollar index rose 27% between the second half of 2014 and 2016; emerging economies excluding China The average GDP growth rate is also lower than the global level.

  So, what impact will this round of Fed rate hikes and balance sheet reductions have on emerging economies?

This actually depends on the rate of interest rate hikes and the scale of the reduction of the balance sheet. If the balance sheet is reduced to the end of next year, the total scale will be around US$1.6 trillion, which is much larger than the US$650 billion scale of the previous round of reduction.

Therefore, emerging economies will face the pressure of foreign capital outflow and the depreciation of their currencies, which will bring down the economic growth rate.

  Nonetheless, there is no sufficient reason to believe that this round of Fed rate hikes and balance sheet reductions will have a greater impact on emerging economies than the previous round of balance sheet reductions in 2017-2019.

Because by the end of 2021, emerging market capital inflows will be about 570 billion US dollars, less than half of the last round of QE.

Moreover, most emerging market economies have already raised interest rates on a precautionary basis, so the scale of further capital outflows may be relatively limited.

What is the impact of this round of Fed rate hike-balance sheet reduction cycle on the capital markets of emerging economies?

  Recently, the U.S. stock market and bond market have been significantly affected by the expectation of raising interest rates and shrinking balance sheets, and there has been a significant decline in stock and bond prices. For example, as of May 6, the U.S. Nasdaq Index has dropped 24% from the highest point last year. %, and the yield on the 10-year U.S. Treasury bond has exceeded 3%.

  In addition, judging from historical data, the rise in mortgage interest rates will increase the cost of residents to purchase houses, curb purchase demand, and put pressure on the real estate market.

In this round of interest rate hikes and balance sheet reduction cycles, the Fed will most likely actively sell its institutional MBS holdings, or further push up mortgage rates.

As a result, U.S. home prices are also expected to fall.

  For emerging markets, the last round of interest rate hikes and balance sheet reductions had a greater impact on emerging markets, and there was a clear differentiation within developed economies.

As this round of Fed rate hikes and balance sheet reductions continues, the prices of commodities with a higher proportion of emerging market demand should obviously fall, and emerging market indices will gradually adjust.

  In this round of U.S. currency tightening, the U.S. dollar index continues to rise, and funds from emerging markets will inevitably flow out. However, due to the quantitative easing period starting in 2020, emerging market stock indexes have not risen as much as developed markets.

Although the pace of monetary tightening this time is relatively fast, and interest rate hikes and balance sheet reductions are almost completely overlapping, considering the outflow of funds from emerging markets this year, the stock index has pulled back, and risks have been released to a certain extent.

  In addition, there is also a question mark about how strong the US dollar index can be. After all, the United States itself also has the risk of economic recession and the bursting of the stock market bubble, which is still different from the capital market situation of the US economy in the last round of rate hike-shrinking cycle. , that is, the risk of a hard landing in this round of the U.S. economy is greater, and the stock market bubble is also greater.

Therefore, if the Fed raises interest rates and shrinks its balance sheet less than expected, the currency depreciation of emerging economies is also expected to be limited.

  In short, this round of Fed rate hike-shrinking balance sheet cycle, my basic judgment: the impact on the capital market of emerging economies may be smaller than the previous round of monetary tightening cycle, but the impact on the global economic pattern and growth model should be sufficient. Attention, we need to observe two major issues. First, will high inflation be prolonged?

The second is to observe the phenomenon of differentiation in the process of restructuring the global industrial chain and supply chain. That is to say, there will also be differentiation among emerging economies. It will not be both prosperous and damaged. Which emerging economies may take advantage of the situation to rise?

(Author Li Xunlei, Chief Economist of Zhongtai Securities)