Why outflows are threatening emerging markets (Part 3 of 6)
The Fed funded the rally in emerging markets
The U.S. Fed provided three rounds of quantitative easing and also kept lending rates as low as possible. The first two rounds of quantitative easing boosted emerging markets, but both ended abruptly. Still, the historical low rates gave investors cheap money and forced them to find higher rates overseas. With the continued mess in Europe, emerging markets were the natural place to go—especially given the commodities bonanza that was boosting the markets.
The third round of quantitative easing (which is the one we’re currently in and have been since late 2012) never shut off, which provided a prolonged boost to emerging markets.
Europe also lent a hand to emerging markets
Europe’s own rescue package also injected funds into the markets, and a lot of the funds ended up invested in emerging markets. Interestingly enough, the story we’re seeing right now between the U.S. and emerging markets is very similar to the story we saw when the European crisis was starting to brew.
The creation of the European monetary union allowed the southern European countries to borrow at much cheaper rates that they could borrow at before. The newly found cheap money flooded the countries. Slowly but surely, labor costs started to rise and eat into the margins.
Since the invested money failed to boost productivity, the southern European countries started to experience ever-growing trade balance gaps. The budget deficits as well started to build up, and it was a matter of time before a country cracked—Greece.
Read on to learn what happened when tapering fears began.
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