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Emerging Markets Hit Hard By Fed’s Trillion Dollar Experiment

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The era of quantitative easing (QE)--where the Fed used trillions of dollars created out thin air to purchase vast sums of U.S. Treasuries and mortgage-backed securities in a bid to stimulate the economy--ended four years ago.

QE was a bold experiment, especially in the latter stages because the Fed channeled money directly toward the troubled housing market by purchasing mortgage-backed securities by government-sponsored firms instead of just traditional Treasuries.

The experiment appears to have achieved the desired effect in some key markets, with equities quickly returning to pre-bust levels by the time QE3 ended.

(Click to enlarge)

In its place, quantitative tightening (QT) characterized by the central bank trimming its massive $4.5-trillion balance sheet, has taken over.

Emboldened by a stronger economy, the Fed began to take the training wheels off by raising interest rates. Then last fall, it went a step further by starting to sell its massive assets, first at a moderate $10 billion-a-month clip, then to $30 billion before hitting top gear at $50 billion per month in July.

And the markets are beginning to feel the heat, mainly in the form of increasing volatility--not just in the U.S. but across global markets as well.

During the QT era:

• the Dow Jones has experienced two 1,000-point nosedives, including its worst point decline in history

• Chinese equities have plunged into a bear market even as trade tensions between the country and the U.S. escalate

• Italy’s bond market blew up briefly

• The Turkish lira and Argentine peso have collapsed Related: These Billion-Dollar Companies Started As Side Gigs

Even formerly beloved tech stocks are no longer immune to the maelstrom, with Facebook Inc. (NASDAQFB) stock recently suffering a $119-billion collapse, the worst single-day wipeout in stocks history. The heavy tech selloff that ensued saw the Nasdaq Composite drop more than one percent for three consecutive days--something last witnessed in 2015.

Just like QE, QT is a massive experiment, and it would be naïve to expect it to have no impact on the markets. You see, QE fueled one of the largest expansions in stocks valuations, and equities have been having hissy fits as the Fed drains the liquidity that sent them booming.

Experts are now warning that what happened to FB is a classic 'late-cycle' event that’s merely a sign of the times. In fact, they are warning investors to buckle up for the QT dump and expect even more volatility as the Fed continues to lighten its still-massive balance sheet:

(Click to enlarge)

Source: CNN Money

Emerging Markets Are Collateral Damage

Vulnerable emerging markets have been bearing the brunt of the QT storm. That should not come as a surprise since the Fed’s incessant rate hikes have strengthened the U.S. dollar at the expense of most EM currencies, thus making it harder for them to repay money borrowed in dollars.

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Consequently, investors have started yanking money out of emerging markets and creating a vicious circle.

The Argentine peso crashed to record lows earlier this year forcing the IMF to arrange a $50 billion bailout. The Turkish lira has plunged 30 percent against the greenback raising fears of yet another emerging market crisis.

The growing spate of market shocks has prompted some experts to persuade the Fed to go easy on its QT program.

Irjit Patel, governor of the Reserve Bank of India, has pleaded with the Fed to slow down its asset sale program, saying that failure to shift course will mean that a crisis in the rest of the dollar bond market is inevitable.

Yet, the Fed insists that we have to take our bitter medicine now. In fact, failure to withdraw the emergency stimulus could lead to serious asset bubbles, with far direr consequences. In fact, the Fed should probably be given props for so far managing to pull off QT without disrupting the economy.

Emerging markets a whole are far more resilient that they were a decade ago. A bumpier ride is the price that everyone has to pay for the markets to safely let off some steam or risk blowing up.

By Alex Kimani for Safehaven.com

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