US stocks fall to end the week in negative territory. The S&P500 lost 1.1% to 2,023 while the Dow Jones fell 1.2% to 17,245. Falling commodity prices driven lower by China’s slowdown and the stronger dollar also weighed on sentiment. Economic data today showed that retail sales and PPI in the US failed to meet expectations. These indicators are showing little signs of inflation and as a result Treasury yields fell. However the dollar index rose which may indicate that investors still expect the Fed to raise rates. Brent oil fell 8% this week to $43.61 as China’s data led investors to believe that demand for raw materials will decrease. Energy, mining, and metals stocks fell in response. Fed funds futures currently price in a 70% chance of tightening in December. The US dollar rose 0.7% against the euro to $1.0747 and 0.3% against a broader group of peers. The 10 year yield fell four basis points to 2.27% and the two year fell 2 basis points to 0.85%. German bund yields fell 14 basis points on the week to 0.56% as a result of eurozone GDP data and expectations for more easing.
Investor sentiment on emerging markets is varying. Some see recent price slides as an opportunity to gain cheap exposure to fast growing economies. Others see emerging markets and recognize the variety of headwinds that will likely be faced over the next several years. Emerging markets have underperformed since 2010, returning -14% compared to a 35% return for developed markets. Pressures on emerging markets include the Fed’s tightening cycle, a stronger US dollar, and falling commodity prices. As a result of outflows from developing countries valuations may appear attractive to some investors looking for contrarian opportunities. Emerging markets would be supported by any improvements in China or a recovery in commodity prices.
Divergent monetary policy will be a key driver of foreign exchange volatility in the months ahead. Most notably the US dollar driven by the Fed’s tightening and the euro driven by the ECB’s easing and the respective interest rates between these two regions are set to go in opposite directions. Comments made by Mario Draghi this week on top of his comments last week suggest that the central bank is concerned of “downside risks stemming from global growth and trade.” These concerns in particular may lead the central bank to further drive the euro lower. On the other hand Bill Dudley this week discussed the possibility of December tightening as a result of improving conditions. Of the outstanding currency shorts against the dollar, 50% of the positions are taken in the euro. BAML believes that the ECB will need to act extensively in December by expanding its program.
Over the past decade African countries utilized international bond markets in order to raise capital. At the time commodity prices were high and economic growth was strong. Now that those trends have reversed bond offerings from African countries will likely cease. African government bond issuance has fallen this year after doubling between 2009 and 2014. When rates were low in developed markets investors were willing to take on the additional yield of frontier economies. China’s slowdown, low commodity prices, the stronger dollar, and rising rates in the US all make it unattractive to hold debt from these countries. Some countries such as Angola, Ghana, and Zambia have continued to test markets with issuances of around $1bn however they were met with little demand and high yields. Zambia was able to issue for 9.8% and Ghana sold debt at 10.75%. In recent years they were able to get significantly lower borrowing costs.