The past few trading weeks have not been kind to emerging markets.

Most major emerging market (EM) currencies were under attack by a broadly stronger dollar, while the prospect of higher US interest rates this year presented downside risks to developing markets. Escalating trade tensions between the United States and China simply added to market anxiety, ultimately exerting further pressure on emerging markets. With growing concerns over a potential trade war likely to fuel risk aversion and deter investors from riskier assets, EM stocks and currencies could be in store for more pain down the road. The negativity created by geopolitical tensions and trade fears is reflected in EM stocks, which have recently slumped to their lowest level since September 2017.

It must be kept in mind that Donald Trump’s tit-for-tat trade war with China remains a significant threat to global stability and economic growth. Global sentiment took another hit after the United States recently vowed to impose a hefty 25 percent tariff on up to $50 billion of Chinese imports. The move prompted an immediate response from China, with Beijing announcing the imposition of additional 25 percent tariffs on 659 US goods worth $50 billion in total. The threat of increasing global protectionism has the potential to negatively impact emerging market exports, consequently weighing on growth in developing markets.

The European Central Bank added to the EM's pain after announcing that it will end its QE programme by the end of the year. Its pledge to keep interest rates at ultra-low levels, “at least through the summer of 2019”, was interpreted as dovish by markets - this has weighed on the Euro and boosted the Dollar. Weaker commodity prices could continue to erode buying sentiment towards EM currencies, especially considering how China has threatened to impose heavy duties on US oil imports. The prospect of easing supply curbs from OPEC-led producers coupled with robust production from US shale may result in lower oil prices, which is likely to add to EM currency woes.

As we head into the third trading quarter of 2018, emerging markets could be poised for further punishment. Market expectations remain elevated over the Federal Reserve raising US interest rates at least two more times this year, while the widening interest rate differential remains in favour of the dollar. With the prospect of higher US rates stimulating fears of capital outflows from emerging markets and global trade tensions promoting risking aversion, EM stocks and currencies remain vulnerable to steep losses.

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