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A return to rationality

Weekly investor research

10 February 2014

The market’s two largest convictions going into 2014 were a stronger US and a crisis in Emerging Markets (EM). Both these views are unravelling. US manufacturing dropped sharply following two quarters of significant inventory accumulation. US non-farm payrolls disappointed for the second month in a row. If this run of US bad data continues the markets will soon begin to ask why the Fed began to taper. Meanwhile, money is still flowing out of EM. Why does weak US data matter for EM investors? Not because EM needs QE flows or low US treasury yields. After all, most of the QE money went into the US stock market, developed market bonds, and G3 currencies. Also, EM rates already price far higher Treasury yields than we will see this year. No, the real importance of these weak US numbers is that they help to restore rationality. The irrational selling of EM over the past 10 months has only been equalled by the build-up of irrational exuberance about the US outlook. Now, perhaps, we can begin to hope for a return to rationality.

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