The Real Reason Behind The Global Market Meltdown

wall-street-etfTony Daltorio:  As the market tumble continues in 2016, pundits point to various causes for the sell-off. Foremost among these are China and oil.

global market meltdown

But I’m of the belief that these aren’t the main drivers behind the weakness. For example, China’s economy has been slowing from its torrid economic pace since 2010-2011. Why should money managers suddenly take notice now?

The real reason behind the recent global market meltdown is the Federal Reserve’s inept policies. Its policies have led to a U.S. dollar that is far too strong for the good of the global economy.

The Fed’s Liquidity Drain

Many think the Fed raising interest rates by a mere quarter point was meaningless. But they’re wrong.

To raise the rate and keep it there, the Fed uses reverse repos to drain liquidity from the financial system. U.S. liquidity is the lifeblood of global financial markets. The Fed drained a record $475 billion on Dec. 31. On Jan. 5, it drained another $170 billion. And it will keep doing so just to keep the federal funds rate at its target range.

That’s bad enough. But the perception of the Fed raising rates even more is worse. That is leading to the overly strong U.S. dollar. On a trade-weighted basis, the dollar soared 22% since July 2014 alone. That’s just about when the Fed began dropping hints about raising rates in 2015.

Fed broad trade-weighted index

Source: Financial Times

The dollar is absolutely crushing the U.S. industrial economy and exports. The industrial sector is quickly heading into recession. Just look at what Michael Ward, the CEO of railroad company CSX Corp. (NASDAQ: CSX), said last week. Pointing to very slow rail traffic at his company, he called it a “freight recession.”

It’s not surprising then that the Dow Jones Transportation Average is already down double digits in 2016. And don’t forget that ISM manufacturing data showed a contraction for the second consecutive month. That’s the first time that happened since 2009.

Dollar Is Clobbering Emerging Markets

But it gets even worse: The Fed and the U.S. dollar are just hammering emerging economies.

The currencies of the emerging economies are being laid to waste by the U.S. dollar. Most currencies are at lower levels than prior financial crises that centered on emerging markets.

Even Mexico, a country doing well and becoming a manufacturing powerhouse, is being affected. The peso is sitting at a record low versus the dollar, at about 18.12 pesos to the dollar.

Many smaller countries not doing as well economically are being forced to devalue their currencies. Devaluation hurts domestic consumers in those countries, since it lowers their buying power.

Countries like Kazakhstan and Azerbaijan have had to devalue their currencies sharply. Others like Nigeria, Oman and Bahrain may be next to fall.

Even strong currency pegs to the U.S. dollar like the Saudi Arabian riyal and Hong Kong dollar may not hold. Both are trading at multi-year lows.

All of which is caused by capital outflows stemming from the too strong dollar. The dollar has had a double whammy effect on the emerging countries that rely on commodities. It has exacerbated the decline in commodity prices, most of which are denominated in U.S. dollars.

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