What Are the Ramifications of Overheating Emerging Markets?

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 |  Includes: ADRE, AGEM
by: Mercenary Trader

The Economist has an interesting piece out asking “which emerging economies are at greatest risk of overheating.”

They explain the six factors that go into their “overheating” index:

  • inflation
  • GDP growth
  • unemployment
  • credit growth
  • real interest rates
  • change in current-account balance

With 100 representing “maximum risk,” Argentina tops the charts.

But the other members of the sizzling seven — Brazil, Hong Kong, India, Indonesia, Turkey, and Vietnam — aren’t far behind.

The Economist’s findings are in line with our “E.M. Hiking Cycle” theme, wherein high profile emerging market nations are forced to raise interest rates in the teeth of inflation.

What are the ramifications of a hiking cycle as things get too hot to handle? That’s where things get tricky.

Some foresee a scenario where Western currencies and bonds weaken dramatically in favor of E.M. denominated assets, with even more capital flowing into economies like Brazil’s.

This would be a negative for the $USD — and potentially the euro too — as global investors focus on not just interest rate differentials but creditworthiness.

The picture may not be so simple, however, as too much capital chasing E.M. assets could accelerate the very overheating that is hoped to be prevented.

That in turn could lead to (1) too-strong currencies choking off exports or (2) a slam-on-the-brakes emergency response, followed by some form of meltdown.

The other $64 trillion question being this: How decoupled are emerging markets, really and truly, from a weak U.S. economy in a post-stimulus environment?

And what kind of aftershocks would a China hard landing have?