The Double Whammy Of EM Crisis And Syria‏

on the back of the prospect of US military intervention in Syria. Coming on top of Fed tapering concerns it is close to a perfect storm for EM currencies. The marked depreciation of EM currencies continued early in the week and the oil price shot higher. Towards the end of the week we have seen some signs of stabilisation, though, on the prospect of a delayed military response.

Although it is positive we see some stabilisation, we believe it is too early to call for a bottom in EM currencies – see EMEA Weekly, 29 August. There is still significant uncertainty about the situation in Syria and the negative economic effects on EM. The countries are faced with a substantial tightening of financial conditions, as money supply declines sharply due to significant capital outflow. The result is falling stock prices, rising bond yields and rate hikes from many of the central banks with Brazil being the latest this week.

In the medium term the weakening of the currencies will be positive for exports and help repair current account imbalances and underpin growth. Rising growth in the US and Europe will also be positive for exports and eventually money will likely return to EM. In the short term, however, focus is on the negative economic effects and the fact that the countries need to get the inflation pressures coming from the sharp currency depreciation under control.

How much impact on the developed markets?
The double whammy from EM and Syria is the biggest short-term threat to the global recovery. So far, however, we believe the positive growth momentum in the developed world is too strong to be threatened.

The rise in oil prices is so far only moderate in the big scheme of things (see chart). There is a risk that oil prices could quickly shoot higher if things spiral out of control in Syria but so far it seems that if there is a response from the US it will be fairly moderate and only last a couple of days. Standard multipliers suggest that a rise of USD10 per barrel in the oil price reduces GDP growth in the OECD area by 0.2 percentage points. This is based on a permanent situation though, and we would judge that even if the oil price rises USD20 it would only be temporary and the multiplier would be much smaller in this case – depending on how long a potential conflict would last. Overall the economic effect from the Syrian crisis is so far likely to be quite moderate.

Stock markets in limbo while bond yields take a breather Flight to safety has become the name of the game and has changed the correlation between bond yields and equities so that lower equity prices now happen alongside lower bond yields. Until recently higher US bond yields were followed by lower equities on the Fed tapering concerns.

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