A general view of China’s economy (Photographer: Qilai Shen/Bloomberg)

China Syndrome Hits Emerging Markets, But Watch for a Recovery

(Bloomberg) -- Emerging markets were left reeling as the U.S.-China trade dispute thrust itself back on to traders’ radars after two Trump tweets killed any sense that the stand-off was near to being resolved. Though it was a sea of red across Asia on Monday, Chinese markets suffered the most as the market reopened from a holiday, with the yuan having the biggest drop in more than three years and the Shenzhen Composite retreating as much as 8 percent.

Won Warning

Elsewhere, the rand was the biggest loser at the start of South Africa’s election week, losing 0.8 percent, and the Mexican peso wasn’t far behind. Turkey’s lira crashed through 6 per dollar for the first time in seven months. Yield spreads on emerging-market sovereign dollar bonds were an average 1 basis point wider versus Treasuries. And watch out for the beleaguered Korean won when markets re-open tomorrow: local traders will also have to grapple with the negative fallout from a North Korean ballistic missile test at the weekend.

Reasons for a Rebound

While it was certainly bloody, there were several reasons why the sell-off might ease in the hours and days ahead.

  • Markets outside Asia, being less closely linked to China’s economy, may prove more resilient to the turmoil.
  • Policy makers will most likely step in to give markets a bit of support -- in fact, Chinese authorities already lowered the reserve-requirement ratio for small banks today.
  • President Xi Jinping’s trade delegation will still travel to the U.S., though the trip will probably be delayed.
  • It wasn’t so long ago that President Donald Trump said the negotiations had been "productive."

For sure, some serious damage has been done, but if the switch can be turned to "off" so suddenly, it may just as swiftly be turned back to "on." Time for cool heads.

Softer Central Banks

The policy-response factor is especially apposite, given that at least six major emerging-market central banks are meeting this week -- at a time when inflation levels across the sector are at historically low levels. The possibility that a longer-lasting breakdown in the trade talks tips the scales more in favor of a Federal Reserve rate cut might give others greater scope to follow suit. Note, Malaysia and the Philippines are the only ones expected to reduce borrowing costs this week, but the goalposts may be shifting toward a faster easing cycle.

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