The emerging market trade has blown up. An “everything bubble” disaster awaits. Meanwhile, what about treasuries?

Via Email, Albert Edwards at Society General discusses Emerging Markets.

Turkey has discovered that high and rising foreign-denominated debt never sits well with a huge current account deficit and a reluctance to raise interest rates. The problem though is that this is not about Turkey or even EM. It is as always, about the Fed.

When the most important person in the free world starts lobbing macro hand-grenades in an effort to drain the swamp, the financial markets will always eventually react badly. No, I am not talking about President Trump with his tweets about imposing tariffs on Turkey. I am actually talking about Fed Chair Jerome Powell draining the global liquidity swamp.

Make no mistake, whatever the macro-idiosyncrasies of Turkey, the key to the current turmoil that is spreading into EM generally, is Fed tightening and the strong dollar. As we have repeated ad infinitum, since 1950 there have been 13 Fed tightening cycles, 10 of them ended in recession and the others usually saw the EM blow up – such as the 1994 collapse in the Mexican peso. The Fed always tightens until something breaks. It is usually its own economy, but sometimes it is the EM’s. And when the liquidity tide goes out we always find out who is swimming naked. If it hadn’t been Turkey it would eventually have been someone else.

To be sure the unfolding EM crisis has been building for many years. And just as investors ignored the naysayers in the run-up to the Global Financial Crisis (GFC), they have ignored the IMF and BIS, who have been cautioning for some years about the explosive build-up in EM debt and especially dollar-denominated debt.

According to the BIS, total dollar-denominated debt outside the U.S. reached $10.7 trillion in the first quarter of 2017, and about a third of this debt is owed by the EM nonfinancial sector. EM specialists, the Institute of International Finance (IIF), have also warned about this build-up in EM foreign-denominated debt. They too note that the EM corporate sector has been leading the explosion of debt, with Turkey standing out for the increase in its exposure since the GFC. Turkey has never managed to escape membership of ‘The Fragile Five’ EM country club.