Understanding fault lines in growth and capital markets informs how the slowdown in the emerging world can affect the advanced economies and the US in particular. The first fault line is the trade linkages which impact end demand less through bilateral trade flow from emerging to developed countries and more through global corporate sector pricing power. The second fault line is the financial linkages between emerging and developed markets which percolate through the global credit, capital flow, and liquidity cycles, and ultimately drive currency and interest rate movements and the risk premia for financial assets.
Wondering whether China’s economy will experience a hard landing overall asks the wrong question. What’s good for China in the long run, i.e., reduced reliance on credit and slower growth as a result, is already a hard landing for China’s trading partners and global goods pricing power. The more appropriate focus should be on determining how reactive Chinese policymakers want or need to be to the deflationary effects of their deliberate pivot away from credit and fixed investment intensive growth to a more consumption led model.
The retrenchment in the EM credit cycle will continue to depress EM import demand. This is the mechanism through which the negative emerging world growth shocks impact the developed economies. Weakness in trade is deflating the global price of tradable goods, sapping pricing power away from US businesses.
Fears of a global growth slowdown driven primarily by emerging markets have caused the USD to appreciate, credit spreads to widen, and equity prices to drop, which, taken together, constitute an implicit tightening in financial conditions. Given the fragile, deflationary pulse of global growth, the transmission of EM economic stress into US financial conditions also creates asymmetric risks to the US economy given monetary policy’s inability to combat any exogenous shock with rates so close to zero already. If the Fed is data dependent, they have no trigger to move yet; if they are market dependent, they should reach the same conclusion.