Emerging markets continue to lose ground in 2014, carrying over the malaise that began with the beginnings of the Fed taper in 4Q 2013. Citi Research published a report yesterday on the potential impact of the ongoing emerging market turmoil on commodity prices, specifically oil. Analysts Seth M. Kleinman et al. point out that the problems in EM economies are already leading to lower demand for oil and that this trend is likely to continue. They also highlight the fact that the long-term, robust negative correlation between oil and the U.S. dollar is clearly breaking down.
Fed taper leading to rising interest rates in emerging markets
The Fed taper has triggered a series of events in the international economy that is forcing major EM’s such as Brazil, India and Turkey to raise interest rates. It boils down to a 21st-century version of a currency war, if you will. The taper is causing increased strength in the dollar, weakening EM currencies and forcing them to increase interest rates to protect their economies.
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The Fragile Five EMs
The Citi Research report follows the lead of the media in calling the emerging markets of Brazil, India, Indonesia, South Africa and Turkey the “Fragile Five“. All five have seen large losses in both their currencies and their equity markets. Kleinman also highlight that the “Fragile Five” account for 250k barrels a day of the IEA’s projected global oil demand growth for 2014 (1.3 m b/d global total).
Negative correlation between oil and USD is breaking down
The analysts also argue that the macroeconomic situation is such that oil prices are not going to be impacted by the U.S. dollar the way they have been since 2008. This say this means the price support previously enjoyed by oil markets when the dollar strengthened is not going to help much this time around, and further supports the bear case for oil prices.