By Mike Dolan
LONDON, March 8 A retooling of the U.S. economy
around cheaper domestic energy and a competitive exchange rate
could be a headwind for developing economies more used to seeing
U.S. growth as a boon.
In a week which saw U.S. equity markets stalk record highs
again and many investors again mulling a long-term turn in the
U.S. dollar, investors have simultaneously been puzzling over
what is shaping up to be yet another year of emerging equity
Theories abound on why stock markets of the fast-growing
emerging giants have lagged bourses of credit-hobbled western
bourses for almost years - valuations, profit squeezes,
liquidity, politics and thin domestic investor bases all play a
But for Manoj Pradhan, Morgan Stanley's global emerging
markets economist, structural economic shifts prompting many
economists to posit a "re-industrialisation" of the world's
biggest economy bear closer scrutiny and raise serious questions
about the relative competitiveness landscape in the years ahead.
Playing on the old adage that when the U.S. economy sneezes
the rest of the world catches a cold, Pradhan reckons the
potential nature of its return to rude health now could send a
chill through many of the developing world's economies too.
"Against the backdrop of a deleveraging U.S. household
sector, it could well be investment and manufacturing that lead
to sustainable growth," he said. "Think for a second about what
that means for emerging markets: it means the U.S. will return
to sustainable growth as a competitor - not as a consumer."
A transformation of the U.S. economy away from more than a
decade of consumption-led growth, which helped underwrite the
export-led booms of the emerging world over the past decade, to
one based more on manufacturing and investment has been mulled
for some time.
A central driver is a shale gas revolution creating a new
cheaper domestic energy source.. But Pradhan
also adds to that the likely releveraging of cash-rich U.S.
businesses and the lagged competitiveness boost of what he
estimates as a 36 percent inflation-adjusted drop in the dollar
against emerging currencies over the past decade.
With slower global growth limiting the total size of the pie
being fought over, a U.S. move down the so-called 'value chain'
into manufacturing could intensify the competition for firms in
Pradhan argues this also challenges an emerging market
outperformance model that relies of continued advances in the
sophistication of exports well above what per capita incomes
would suggest. Research shows Chinese exports, for example,
three times more advanced than incomes would point to.
And if the U.S. moving down the value chain puts a ceiling
on this advancement for the likes of China, Malaysia, Brazil,
Russia, South Korea and Taiwan, then they may have to accelerate
their owns shifts more toward domestic sources of consumption
away from heavy reliance on exports.
As ever, there will be winners and losers. Mexico's border
and free trade links with the U.S. mark it out as a beneficiary
while South Korea's superior global brands may insulate it too.
The effects on exporters of raw materials or on energy importers
may also be softened.
RISING DOLLAR AND T-BOND YIELDS
However, this potential U.S. mega trend comes at a time of
other financial market headwinds for emerging market investors.
Many economists are eyeing a long-term recovery of the
dollar on the back of both the "re-industrialisation" story as
well as expectations about the Federal Reserve being the first
of the world's major central banks to "normalise" monetary
policy away from money printing over the next two years.
And periods of a rising U.S. dollar have often railroaded
emerging markets by tightening global financial conditions,
squeezing dollar borrowing by emerging market firms and limiting
U.S. investor outflows overseas. The serial emerging crises of
the late 1990s coinciding with a multi-year dollar rally was a
classic case in point - channelling many U.S. investors back to
'safer' emerging or growth markets back home in Silicone Valley.
While Friday's upbeat U.S. employment report for February
underlines the U.S. recovery story for now at least, long-term
dollar bulls suspect the currency may be bottoming out.
"The dollar is cheap," said hedge fund manager Stephen Jen.
"One does not need to run complicated valuation models to know
that it is much cheaper to travel in the U.S. than anywhere in
Europe and many emerging markets."
After years of Fed 'debasement', he added, "it has simply
become difficult to artificially depress the dollar further.
What's more, the impact on recently booming emerging bond
markets of rising U.S. Treasury yields - where 10-year yields
jumped above 2 percent to their highest level in almost a year
after Friday's payrolls data - will hurt too.
"Rising U.S. yields are potentially a big problem for flows
to emerging markets," said Maarten Jan Bakkum, emerging markets
strategist at ING Investment Management, adding they increase
the chances that the Fed will take liquidity off the table.
"You can expect more nervousness in emerging markets."