Emerging markets crisis or the cost of unwinding?

January 31, 2014 05:17 AM

The financial press is awash today with warnings that investors in emerging markets' securities are now being punished by currency weakness, stalling economic growth, whatever. This may be true but why, then, is it impacting the U.S. stock and bond markets as well? Shouldn't they be benefiting as emerging markets investors seek a "safe haven" in this country? Instead, U.S. stocks and bonds are also taking a beating.

As a lawyer (not an economist) I should not venture an answer but I will. We have our own home-grown problem known as "quantitative easing" or "QE3." It has virtually eliminated any real yield from U.S. bonds, inducing people to switch to the equity markets that did remarkably well in 2013. And now we have a gradual ending ("tapering") of that program.

This tapering means that bond yields are almost certain to rise, but only for future issuances. Existing bonds must fall in face value in order to compete. Meanwhile, investors who would prefer to be in bonds are expected to switch out of equities and into the new higher-yield bonds, causing stock prices to fall. A twofer of bad news for existing stock and bond holders.

What does this have to do with the emerging markets crisis? Almost nothing except that, while the tapering continues, emerging market investors have little incentive to buy existing U.S. stocks and bonds, both of which are heading south. Or, maybe if we view the Federal Reserve Board as a foreign enterprise.

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