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TheStreet Open House

Global Macro: Emerging Markets Getting Slammed

NEW YORK (TheStreet) -- Emerging-market equities have been hit hard this week as talks of the Federal Reserve reducing stimulus have renewed and Chinese industrial data came out below expectations.

Emerging markets are heavily influenced by both U.S. interest rates and Chinese economic health. Low interest rates allow for excess liquidity in the system, which ultimately flows to emerging economies in South America and Asia, and China is a major importer of raw materials, which are typically produced by smaller surrounding economies that specialize in either energy or metals.

With a U.S. budget deal in the works, investors fear tapering could be near. Treasury bonds have been sold heavily as of late, as even the bond auction on Thursday priced 30 year interest rates significantly above expectations.

The budget deal doesn't solve all of the country's fiscal issues, but it is a step in the right direction. Alleviating some of the burden off the Fed could be enough of a catalyst for reduced stimulus.

Meanwhile, emerging economies are linked to China through their import/export relationship. Higher demand for Chinese exports creates a need for more resources, which in turn causes a stronger and steadier revenue stream to the producers of those resources.

A proxy for emerging markets is Australia. Although it is a developed country, it is similar to emerging markets in that its economy relies heavily on raw materials exported to China. As China's growth has slowed, Australia's output has decreased.

The Reserve Bank of Australia stated on Thursday that the country's currency needs to fall against the U.S. dollar for its exports to remain competitive in the world market. As long as global economic woes continue to hurt China and the developed world, emerging markets will suffer.

The chart below of EEM shows that it may drop to 52-week lows over the coming months. The index pushed higher at the end of the summer as quantitative easing looked to remain intact until at least the end of the year. The belief was that the government shutdown would distort economic data in the fourth quarter and force the Fed to continue to pump money into the system for stabilization.

With more fiscal certainty due to the budget deal and strong economic data, the tone has shifted. A bearish reversal pattern is forming on the chart as the year comes to an end. If Chinese data continue to underperform and U.S. monetary policy becomes less dovish, the emerging-market index may decline considerably.

EEM ChartEEM data by YCharts

At the time of publication, the author had no position in the index mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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