It was an emerging markets roller coaster this week. The Turkish lira hit fresh lows Monday versus the dollar, escalating fears of emerging markets contagion and driving shares of EM stocks lower. After a modest relief rally, major EM indexes sold off sharply Wednesday following weaker than expected economic data out of China, as well as weak earnings from Chinese technology giant Tencent. Thursday marked another small recovery as news surfaced that China and the US were open to resuming trade discussions, but it wasn’t enough to offset weekly losses in developing markets. US stocks were able to finish the week modestly higher.

Weekly Returns

S&P 500: 2,850 (+0.6%)
FTSE All-World ex-US (VEU): (-0.9%)
US 10 Year Treasury Yield: 2.86% (-0.01%)
Gold: $1,184 (-2.3%)
EUR/USD: $1.144 (+0.3%)

Major Events

• Monday – The Turkish lira sold off sharply, sending shares of emerging market stocks lower on fears of foreign currency debt contagion.
• Tuesday – A car crashed outside British Parliament in a suspected terror attack, injuring several people.
• Tuesday – Chinese spending on fixed-asset investments slowed to 5.5% in the January to July period, down from the 8.3% growth in the same period of 2017.
• Wednesday – Shares of Chinese technology giant Tencent dropped after reporting weaker than expected results, partially blaming Chinese regulators for the miss.
• Wednesday – The SEC subpoenaed Tesla over Elon Musk’s tweet to take the company private.
• Thursday – Walmart reported better than expected results, echoing other retailers and reinforcing strength in broader US consumer spending.
• Friday – President Trump announced that he is having the SEC consider moving the reporting requirement for public companies to a six month cycle, rather than quarterly.

Our Take

As if the trade war and Fed tightening haven’t created enough volatility this year, in walks Turkey and renewed fears of EM contagion. To recap, emerging market countries with larger amounts of dollar denominated debt have faced pressure this year amid the US Fed raising rates. The tightening has increased the cost of borrowing and fueled a rally in the dollar, making it more expensive for these countries to pay existing US debt.

Argentina already received a bailout, and Turkey has been hit hard in recent weeks given its outsized balance of foreign currency debt, as well as its defiant stance against the US and ongoing trade war. The Turkish Lira has sold off sharply, hitting fresh lows on Monday before rebounding on a $15 billion support package from Qatar. All of this is fueling fears that selling pressure could spread throughout the EM world.

In our view, the threat of contagion seems fairly low. Turkey stands out among its EM peers with one of the highest foreign currency debts relative to GDP. And despite a few other “at risk” players, most EM countries have their foreign debts under control. Turkey is more the exception than the rule, meaning the heavy selloff in emerging market stocks could simply be a knee-jerk reaction. It’s worth pointing out Turkey represents less than 1% of most major EM indices.

The bigger story for EM will likely be China, where growth has slowed of late. Amid softer economic data and an ongoing trade spat with the US, the government has already taken a more accommodative stance to re-stimulate the economy. At this point it remains unclear whether these efforts will prove successful, and the ongoing trade war could be another potential headwind should it escalate from current levels. The good news, at least, is it appears the US and China may finally be open to resuming discussions.