• October 8th, 2018
• By Midsilver Investment Limited

As 2018 transitioned into its latter half, financial markets experienced a dramatic shift in sentiment. The resurgence of the US dollar and amplifying trade conflicts contributed to an inconsistent tightening of global financial conditions. Even as the Federal Reserve methodically withdrew monetary support due to the accelerating US economy—partly invigorated by the prior year's fiscal push—financial conditions in the US paradoxically became more lenient. However, financial conditions became slightly stringent in the credit markets of several advanced economies (AEs). This was starkly opposed to the emerging market economies (EMEs), which contended with diminishing currency values and declining borrowing access, with a few showing evident signs of economic instability.

There was a noticeable departure in the behavior of US financial markets compared to others. US equities outpaced those in both advanced and emerging markets, while its market volatility saw a decline. The continuous monetary support by institutions like the ECB and the Bank of Japan (BoJ), along with a rush to safer assets away from stressed EMEs, restricted the surge in long-term US government yields, even with an impending increase in Treasury debt. Consequently, the US yield curve experienced further flattening, teetering on the verge of inversion. In general, US financial conditions remained more flexible than in other leading AEs. For instance, credit spreads for US corporate borrowers remained mostly unchanged from June to mid-September. In contrast, European corporates encountered slightly expanded spreads, partly due to increased borrowing expenses encountered by some European banks, reflecting stress within the euro zone and certain banks' exposure to fragile EMEs.

The constriction in EMEs' financial conditions exacerbated pressures experienced earlier in the year. Amid a robust US dollar, intensifying trade disputes, and additional indications of China's economic deceleration, portfolio investments remained subdued. Exacerbated by inherent weaknesses, certain nations saw capital outflows, with policy or political ambiguities intensifying market turbulence in specific regions. Currency devaluation went hand in hand with elevated sovereign spreads, encompassing instruments in both US dollars and native currencies. The aggregate impact on EME assets since global trade conflicts heightened in late March in certain aspects surpassed the repercussions of the 2013 tapering episode or the renminbi's devaluation in August 2015. Nonetheless, sovereign spread metrics generally remained below past incidents, and the spillover from the hardest-hit nations was minimal. Yet, by mid-September, investors held lingering apprehensions about the potential escalation and spread of financial strain in EMEs.