The underlying economic troubles in emerging markets surfaced recently with Turkey, Argentina and India making headlines as their markets tumbled.

Meanwhile, trade tensions between China and the United States have brought an even more cautious tone across international markets.

While the New Zealand stock market has been able to navigate most of these headwinds to date, concerns are growing over the contagion risk emerging markets pose to our economy.

China and emerging markets were, to a large degree, the saviours of the global economy during the depths of the financial crisis in 2008, as their ability to take on debt and stimulate demand helped to support the global recovery.

New Zealand’s connections with China also allowed us to largely sidestep the economic pain felt across the United States and Europe – as the nation became a more important regional trading partner, and credit creation from China and other emerging markets supported domestic property markets.

Now, looking to the future, it may not be trade tariffs that stand to be China’s biggest challenge – but this massive expansion of credit, and the extreme level of both personal and corporate debt it has created.

In an attempt to manage this problem, China’s government has continuously stepped in to stimulate growth, but there are tell-tale signs this has become unsustainable – as it now takes more than USD$4 of debt to generate just USD$1 of economic growth.

Overcapacity is a major issue and poses a significant deflationary risk to the rest of the world as China looks to export their economic imbalances. It’s this threat which has prompted the subsequent push-back from the United States in the form of increased tariffs.

Turning to the emerging markets, many see the growth in US currency and interest rates as the cause of their troubles. In reality, these markets had been showing signs of economic stress for some time before the USD started to strengthen – and the increasing value of the USD is not the cause but a consequence of weakening local emerging market economies and domestic currency imbalances.

Excessive government spending, the likes of which we’re seeing in Venezuela and Brazil, has led to dislocations and loss of investor confidence, followed by a flight of capital that has putting additional pressure on those currencies.

This in turn increases the cost of servicing debts denominated in foreign currencies, predominantly USD – increasing the demand for USD, and helping to drive its value even higher. This cycle feeds on itself and increases the domestic economic risks.

Ultimately, this has caused the breakdown of synchronised global economic growth, with emerging markets being unable to maintain the pace of growth set during the initial years of the current, decade-long global economic recovery.

This could be further amplified by the divergent monetary policies we’re seeing from the central banks of developed and emerging markets – which could further tighten financial conditions in emerging markets, benefiting the US dollar and seeing emerging market economies stagnate.

Domestically, we have seen the NZD devalue by over 15 per cent this year, from its January highs – and despite a cheaper currency, exports have not experienced a major lift, with our trade deficit widening in September.

Australia has experienced a similar depreciation, with the AUD down 15.8 per cent over the same period.

With the combination of this slowing global demand for Kiwi exports, coupled with a weaker NZD and stronger oil prices, this could mean challenging times ahead in the form of greater pressure on businesses and consumers.

While concerns over emerging markets are valid, the good news is that the New Zealand economy is unlikely to fall off a cliff anytime soon – but rather we may experience a period of stagnation as our major trading partners work through their overcapacity and saturated debt levels.

Four in 10 UK companies say they will be forced to trigger further contingency plans as soon as next month if Theresa May’s Brexit team does not provide more clarity on a potential divorce deal with the EU.

Those plans include cutting jobs, adjusting supply chains outside the UK, stockpiling goods and relocating production and services overseas.

Of those with contingency plans 44 per cent say they will stockpile goods in anticipation of delays at the border after Brexit.

A survey of small and large UK companies by the Confederation of British Industry found that 80 per cent of firms believe Brexit has already had a negative effect on investment decisions.

This reluctance to invest is likely to have a knock-on effect for jobs, wages and living standards and could further damage UK productivity which already lags behind many other developed economies, the CBI warned.

The latest research further highlights the critical need for progress in the Brexit negotiations and comes as the prospect of no deal being agreed in time looms larger than ever.

The EU’s chief negotiator Michel Barnier said on Friday that a deal could still be sunk at the last minute by the Irish border issue, despite 90 per cent of terms being agreed.

Speaking after a summit in Brussels where EU leaders discussed progress in talks, Michel Barnier said he was “still not sure we’ll get” a withdrawal agreement.

Carolyn Fairbairn, CBI director-general, warned that the situation was now urgent and that “the speed of negotiations is being outpaced by the reality firms are facing on the ground”.

Almost a fifth of firms have said they have already been forced to trigger contingency plans and many more are readying themselves for a no-deal scenario.

“Unless a withdrawal agreement is locked down by December, firms will press the button on their contingency plans. Jobs will be lost and supply chains moved,” Ms Fairburn said.

“The knock-on effect for the UK economy would be significant. Living standards would be affected and less money would be available for vital public services including schools, hospitals and housing.

“Uncertainty is draining investment from the UK, with Brexit having a negative impact on 8 in 10 businesses.

“From a multinational plastics manufacturer which has cancelled a £7m investment, to a fashion house shelving £50m plans for a new UK factory, these are grave losses to our economy.”

Support free-thinking journalism and subscribe to Independent Minds

At the latest EU summit, negotiators made little in the way of concrete progress, and leaders agreed to shelve a planned November meeting where a Brexit deal was supposed to be finalised – stating that “decisive progress” had not been made in time.

“Ninety percent of the accord on the table has been agreed with Britain,” Mr Barnier told French broadcaster Inter radio.

“I’m convinced a deal is necessary, I’m still not sure we’ll get one.”

This is an uncertain moment for global trade. Longstanding agreements between the United States and its biggest trading partners have been called into question by President Donald Trump. The United Kingdom is working to disconnect itself from the European Union.

Look more closely, however, and another, less-told story appears. Trade among emerging economies, with China often serving as the anchor, has been rising sharply. The world is not standing still.

Content by twofour54

How innovative VR can prosper in a creative ecosystem

We are only at the beginning of the possibilities of virtual reality. In UAE, it’s finding a role in education.

We estimate that goods trade between emerging economies, both with China and not, encompasses 20% of the value of all global trade, up from 8% in 1995. Trade between China and other emerging economies has risen 11-fold in that time, while trade among emerging economies not involving China has risen six-fold.

China runs a big trade surplus of $170 billion with emerging economies, although this is starting to shrink. Its share of labor-intensive manufacturing exports from emerging economies peaked at 56% in 2014. That shrunk to 53% in 2016 because of rising production costs.

How Trump’s trade war with China could backfire 01:35

Other emerging-market countries have been able to fill the gap left by China in labor-intensive manufacturing, including products such as textiles. Some have put reliable infrastructure and business-friendly investment conditions in place. Some countries have specialized. Vietnam has been the biggest beneficiary of this shift, through rapidly growing exports of electronics, among other things. In India, the fastest-growing manufacturing sectors include furniture-making, automotive and pharmaceuticals. Ethiopia, Rwanda and Vietnam have grown their textile exports rapidly, posting annual growth by more than 15% in the past five years. Bangladesh has also become a leading textile exporter — the sector employs about 5% of the labor force there.

China, for its part, wants to increase its share of R&D and capital-intensive production, ceding some growth in labor-intensive production. Wages in China have been rising — and that has allowed emerging economies with lower wages to better compete. This trend, if it endures, is good news for low-cost, labor-intensive manufacturing in emerging economies. Manufacturing has long been an essential pillar of development, creating jobs and economic growth. Ethiopia, for example, increased manufacturing employment by almost 10% annually between 2000 and 2010.

MORE FROM PERSPECTIVES

It’s an economic tenet that, eventually, manufacturing employment peaks as countries reach a higher stage of development. In recent years, that peak has been happening earlier than it used to. Harvard economist Dani Rodrik has dubbed the phenomenon “premature deindustrialization.” Nonetheless, our analysis suggests there is still room for manufacturing going forward in emerging economies. Moreover, the growth of trade between emerging economies, including China, creates a strong position for China itself. In the years ahead, China, now the world’s second-largest economy and growing faster than the United States, can become the center of an expanding trade ecosystem.

But trade can also continue to help other, smaller emerging economies grow. We studied the per capita GDP of 77 countries over half a century. We found that countries that raised their share of the global trade of goods have done significantly better than those that did not. Indeed, for the 18 outperforming countries, the share of trade inflows and outflows rose from just 7% in 1980 to 29% in 2016. That 22 percentage-point increase is matched by a 22 percentage-point decline among outflows and inflows of goods in high-income countries in the same period.

Our research also shows that the top-performing companies from those 18 countries made a clear priority of trade and global expansion. The bottom line is that trade works — it helps lift emerging economies and their businesses.

LONDON, Oct 23 (Reuters) – An ugly start to European trading pushed world shares towards their lowest level in a year on Tuesday, as negative drivers from Saudi Arabia’s diplomatic isolation to worries about Italy’s finances and trade wars piled on the pressure.

Selling escalated from Wall Street into a heavy selloff in Asia before hitting Europe, which was facing a fifth day of uninterrupted declines.

The tech sector posted the worst performance after chipmaker AMS plunged 17 percent as its outlook triggered alarm bells, but there was a broader force at play.

The pan-European STOXX 600 was near a two-year low with almost half of its stocks now in bear-market territory — down 20 percent from their peak.

Germany’s DAX also fell to late 2016 lows, London’s FTSE was down near April lows, and MSCI’s world share index was just two points of a one-year low.

“This morning weaker stocks in Asia raised some eyebrows and overall sentiment is suffering from trade tensions, Italy to Brexit; a concoction of concerns,” said ING strategist Benjamin Schroeder.

The euro also fell towards a two-month low and Italian bonds struggled before a European Commission meeting that could see Brussels take the unprecedented step of demanding changes to Italy’s recently laid out budget plans.

That has bred some doubt about the European Central Bank raising interest rates next summer, leaving the euro at $1.4390 . Doubts about Britain’s prime minister, mired in a stalemate over Brexit, kept the pressure on sterling.

All that contributed to the risk-averse mood, with the safe-haven Japanese yen and Swiss franc strengthening while higher-yielding currencies like the Australian and New Zealand dollars fell.

“The prospect of a normalisation of (ECB) monetary policy was the main reason why the euro was able to appreciate over the past year. However, there is a rising risk that this support is now going to crumble,” Commerzbank analyst Thu Lan Nguyen said.

SAUDI TENSIONS

Markets were also waiting for Turkey’s president to reveal his country’s take on the killing of Saudi Arabian journalist Jamal Khashoggi at a Saudi consulate in Istanbul this month.

Saudi Arabia, a top crude oil exporter, faces international pressure to provide all the facts about an incident that has raised a global storm and added the threat of sanctions against the kingdom to a list of market concerns.

U.S. President Donald Trump said on Monday he was not satisfied with what he had heard from Saudi Arabia about the killing, but expressed reluctance to punish the kingdom economically.

Investors worry that may lead to Saudi retaliation through crude oil, although a Saudi pledge to play a “responsible role” and keep markets supplied held down crude prices on Tuesday.

Front-month Brent crude oil futures were at $79.51 a barrel, down 0.4 percent. U.S. West Texas Intermediate (WTI) crude futures were at $69.12 a barrel, dropping 0.35 percent.

Asia’s overnight tumble gave back some of the ground the region had clawed back over the last two sessions.

MSCI’s broadest index of Asian shares dropped 2 percent to a 1 1/2-year low, with declines in many of the region’s heavyweight bourses even more pronounced.

South Korea’s Kospi and Hong Kong’s Hang Seng both fell 3 percent and Japan’s Nikkei lost 2.7 percent.

“We’ve got a few negative factors when market sentiment was already fragile,” said Hiroyuki Ueno, senior strategist at Sumitomo Mitsui Trust Asset Management. “And earnings from some Japanese companies were weaker than expected, with some starting to blame trade wars.”

The yen gained 0.4 percent amid the risk-off mood to 112.42 to the dollar.

The yuan was little changed but stood near Monday’s 21-month low of 6.9445 per dollar in the onshore trade on expectations China will pursue looser monetary policy to cope with pressure from U.S. President Donald Trump on tariffs.

OIL prices have a knack of jumping at the most inconvenient times. As in 2007, for instance, when the price of a barrel soared into triple digits, destabilising a world economy already heading for a financial crisis. Or, for that matter, now. At more than $80 per barrel, Brent crude is nearly twice as costly as in the summer of 2017 and three times as pricey as in early 2016 (see chart, left panel). Dear oil does not yet mean a crisis. But it is putting emerging markets, already labouring, under further stress.

That oil should once again be causing trouble is a bit of a surprise. Half a decade ago prices in excess of $100 per barrel seemed to be a permanent feature of the economic landscape. But in 2014 prices crashed, as America’s shale boom turned the market on its head. The world quickly embraced the idea of a “new normal” for oil: in which large-scale, flexible shale production in America promised to keep prices stable and moderate. Americans scarcely had an opportunity to swap their Priuses for gas-guzzling SUVs before the market turned again.

Who loses sleep over a potential “thief in the night”? Bond market participants certainly haven’t been too worried lately. Former Federal Reserve Chair William McChesney Martin used that turn of phrase to describe price inflation during his nearly two-decade run at the Fed.

Interest rates are (quite logically) inextricably linked to inflation expectations. Lenders typically expect their borrowers to compensate them for the expected erosion in real, or inflation-adjusted, value of the funds between the time they are borrowed and the time when they are eventually repaid. This inflation compensation is implied within the agreed upon interest rate for any given loan. As expectations for inflation increase, interest rates move higher.

In the late 1990s, the U.S. Treasury Department embarked on a novel approach to index the principal amount of some of its bonds to inflation. The actual amount a bondholder (i.e. lender) receives at maturity for these Inflation-Protected Securities, or TIPS, increases with inflation. Since a holder of TIPS is insulated from inflation risk, we can compare the market-driven yield for traditional Treasury notes with TIPS to help discern the inflation expectations of Treasury bond market participants.

The chart below depicts the implied expected annual inflation rate for the next 10 years (white line with blue body) alongside the 10-year U.S. Treasury yield, charted over the past 12 months. One can immediately discern a strong correlation between the two (proving our above point that rates and inflation expecations are positively correlated). One might also note that while the two moved up by comparable magnitude through January, since then inflation expectations remain anchored at 2.1-2.2 percent but the nominal 10-year Treasury yield has continued its march higher, especially recently.

Source: Bloomberg LP

This begs the question, if the inflation outlook has not changed, why do interest rates keep rising? We’ve heard optimistic market commentators citing stronger economic growth as the key driver for higher rates. This is a conceivable explanation but there are two other big factors which are actually quite important.

First, the U.S. federal government is running larger budget deficits. In light of the recently passed tax cuts, revenue for the 2018 fiscal year is estimated by the Congressional Budget Office to be essentially flat, while spending increased by 4.4 percent year-over-year.

Secondly, the U.S. Federal Reserve’s planned balance sheet reduction, to unwind extraordinary financial crisis era stimulus, recently hit high gear. Starting in October 2018, the Fed will allow $50 billion per month of government-guaranteed bonds to mature without reinvesting, effectively soaking up an extra $50 billion of global liquidity each month, up from a rate of $10 billion this time last year.

Net federal government borrowing literally doubled over the past year, when comparing the past 12 months through Sept. 30 to $1.04 trillion, according to SIFMA data. Trillion! There is just a ton of incremental government borrowing for the market to absorb. Basic economics argues for a higher cost of something as demand increases. Higher rates have wide-ranging implications for all sorts of asset prices. The thief is currently at bay, but interest rate floodwaters are ominously rising.

NEW YORK, Oct 5 (Reuters) – The U.S. bond market’s gauges on investors’ inflation outlook rose on Friday as government data showed a steady rise in wages and the jobless rate hitting a 49-year low in September, hinting at some building in price pressure.

The latest labor figures reinforced the view that domestic wage inflation is accelerating, which would allow the Federal Reserve is keeping raising short-term borrowing costs gradually in an effort to keep the economy from overheating.

The upbeat payrolls report also spurred selling in the bond market for a third straight day, propelling the 10-year Treasury yield to a seven-year peak near 3.25 percent.

“You are seeing some wage acceleration so it’s natural you see some people selling,” said Robert Tipp, chief investment strategist at PGIM Fixed Income in Newark, New Jersey. “I think it’s overdone,” he said of the market rout.

Average hourly earnings grew 0.3 percent in September, bringing their year-over-year increase to 2.8 percent.

This compared with a similar monthly rise in August and an annual gain of 2.9 percent which was its largest yearly increase in over nine years.

Moreover, the unemployment rate fell to 3.7 percent, which was the lowest level since December 1969.

While the bond market took another beating on Friday, some investors increased their holdings of longer-dated Treasury Inflation Protected Securities based on evidence of further wage growth.

The yield spread between 10-year TIPS and regular 10-year Treasuries, or the 10-year inflation breakeven rate, was 2.17 percent, the highest level since May and up 0.90 basis point from Thursday, according to Tradeweb data.

However, the five-year TIPS breakeven rate weakened marginally to 2.06 percent, just below 2.07 percent set on Wednesday, which was the highest level since July 13. (Reporting by Richard Leong Editing by Tom Brown)

FRANKFURT (Reuters) – Soured credit, cybercrime and Brexit are among the biggest risks facing euro zone banks in 2019, the European Central Bank said on Tuesday, as it set out its supervisory priorities for the year ahead.

The euro zone’s growth has reduced overall economic uncertainty, but global risk factors from protectionism to a hard Brexit and emerging-market turmoil are growing and warrant closer monitoring, the central bank said. It keeps watch over 118 of the biggest euro zone banks.

“Compared to last year, there has been a substantial decrease in risks stemming from economic and fiscal conditions in the euro area, mostly due to a favourable cyclical momentum,” the ECB said in a regular risk assessment exercise.

“At the same time, geopolitical uncertainties and risks of repricing in financial markets have increased. Advances in digitalisation exacerbate the risks related to banks’ legacy IT systems and cyberattacks.”

Other notable risks include a repricing in financial markets and the impact of record-low interest rates on bank profitability, it added.

With regard to Brexit, the ECB stressed that banks need to be ready for any outcome, since no agreement has been reached just months before Britain is due to exit the European Union.

“Banks’ preparedness for Brexit remains a high priority for ECB Banking Supervision,” the ECB said. “ECB Banking Supervision will further prepare to take over the direct supervision of a number of institutions that are newly identified as significant owing to the Brexit-induced relocation of activities.”

It added that it will continue to press banks to reduce their stock of non-performing loans after notable progress this year and will also scrutinize lending practices to mitigate potential risks.

It will also conduct a targeted review of banks’ internal models for calculating risk to reduce unwarranted deviation from its own expectation.

Emerging market shares rose on Friday while currencies remained under pressure against a backdrop of uncertainty surrounding Brexit, in what has been a largely positive week driven by lower oil prices and cautious trade optimism.

The broader index for emerging markets was on track for a 0.7 percent weekly gain with shares in Turkey and South Africa gaining nearly 1 percent each on the day.

A possible easing of Sino-U.S. trade tensions boosted emerging shares although investors remained cautious about an actual agreement.

While China sent a written response to U.S. demands for trade reforms, Washington said this was unlikely to prompt a breakthrough at talks between Presidents Donald Trump and Xi Jinping later this month.

“We are of the view the summit will not lead to a trade agreement between the two countries, rollback of existing tariffs, or even a commitment to not implement further tariffs,” said Citigroup in a note. “But the outcome may be similar to the U.S.-North Korean summit… a path to de-escalate tensions going forward.”

Mainland Chinese shares finished higher on stimulus measures to support markets and private businesses. But, Taiwan’s shares fell 0.3 percent on the back of chipmakers clocking hefty losses following Nvidia’s drop overnight.

A softer dollar did little to benefit most currencies even as the sterling fell after a series of resignations rocked British Prime Minister Theresa May’s government and threw into doubt her long-awaited Brexit agreement.

“There is generally a weak risk environment related to the issues in Europe around Brexit and the uncertainty there,” said Jakob Christensen, chief analyst and head of EM research at Danske Bank.

“In addition the weakness in the global economy is the background that adds to the anxiety. These two factors play a role here and despite the lower dollar, they add concerns about risk assets,” added Christensen.

The Russian rouble turned negative after trying to test a 2-week peak against the dollar as traders assessed geopolitical risks, while a recovery in oil prices pushed stocks higher.

The Chinese yuan declined 0.1 percent against the dollar, but was on course for a winning week as comments from the central bank eased pressure to lend.

Chinese financial institutions should take steps to reasonably manage the pace and intensity of credit supply, the central bank said on Friday, following a sharp slowdown in credit growth last month.

The Turkish lira was little changed despite industrial production data showing a 2.7 percent fall in September, further evidence that the country is poised for a recession.

On the week, however, the currency is on course for a 2 percent rise thanks to a jump on Thursday after a report that the U.S. government is exploring possible ways to remove U.S.-based Muslim cleric Fethullah Gulen, a staunch critic of Turkish President Tayyip Erdogan.

Ankara’s demand for Gulen’s extradition has been one element in a dispute with Washington.

Eastern European currencies were mostly steady against the dollar. The Polish zloty was little changed after a newspaper report that the country’s central bank governor may resign.