Western corporates feel the EM heat

"How much should US domestic monetary policy restrain itself for the stability of global conditions?" This question was asked at the Jackson Hole symposium for central bankers last year, and this week it became perfectly clear that the Fed had little concern about events beyond US borders.

As expected, the Fed stood firm and continued to taper its QE programme by $10bn. The tapering has caused interest rates to rise, a trend that Alexandre Tombini, the governor of Brazil's central bank, likened to a "vacuum cleaner" - sucking funds from emerging economies.

Brazil is one of several countries that have suffered in recent weeks from capital outflows and market volatility, though the movement in the Latin American sovereign's CDS spreads were modest in comparison to others. Its currency has depreciated over the past year, and there was evidence today that this is damaging corporates in the developed world.

Electrolux posted earnings that were significantly below expectations, and blamed currency headwinds in Brazil and other countries. During the post-results conference call, the company said that the adverse FX conditions are likely to get worse in 2014. Electrolux's CDS spreads widened by 17bps to 99bps, making it the worst European performer today. Its US rival Whirlpool posted lower than expected profits yesterday, and its CDS spreads widened by a further 11bps to 116bps.

So it seems that QE tapering and the ensuing capital flight from emerging markets can have a knock-on effect on Western multinationals. But the Markit iTraxx Europe has closed the week at 82bps, 2.5bps tighter than last Friday's level, and the Markit CDX.NA.IG is 1bp tighter at 71.5bps. This masks considerable volatility, particularly on Wednesday, when both indices traded in a wide range. The real damage was done last week, when European and North American credit markets lost significant ground.

The Fed appears intent on pursuing its policy of reducing its bond purchases, though it will be interesting to see if new chair Janet Yellen takes a different tack than Ben Bernanke (it seems unlikely). Higher yields will benefit developed market bonds, but trigger more outflows from emerging markets. Talk of panic in the media is probably overblown - EM spreads are nowhere near where they were during the financial crisis. However, there are countries that are clearly more vulnerable than others - large current account deficits and political instability are warning signals - and the Fed's understandable domestic focus could leave them in the firing line.

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