EMERGING markets are at risk of negative fallout from an eventual rise in U.S. interest rates despite more settled conditions in financial markets in the fourth quarter, Bank for International Settlements (BIS) said yesterday.

    “The calm has been uneasy,” said BIS economics department head Claudio Borio. “Very much in evidence, once more, has been the perennial contrast between the hectic rhythm of markets and the slow motion of the deeper economic forces that really matter.”

    In its quarterly review, BIS, a Switzerland-based consortium of central banks, noted that emerging markets settled down after a turbulent summer when volatility in China’s stock market and currency upended financial markets.

    “The short-lived market response might suggest that [emerging markets] could ride out the prospect of U.S. monetary tightening,” BIS said, referring to financial market trends in emerging markets since mid-November.

    “However, less favorable financial market conditions, combined with a weaker macroeconomic outlook and increased sensitivity to U.S. interest rates, heighten the risk of negative spillovers to [emerging markets] once U.S. rates do start to rise.”

    Borio noted that the outlook over the short term for key emerging market economies was little changed recently despite the greater calm that prevailed in markets. Brazil and Russia still confronted deep recessions, he noted, and China’s economic outlook showed few signs of improving.

    Although international lending to China increased modestly during the second quarter from the first, “international bank lending to China has lost significant momentum and contracted by 3 percent in the year to end-June 2015,” BIS said in its report.

    The U.S. Federal Reserve is widely expected to raise interest rates at its mid-December meeting after keeping its key policy rate pinned near zero for the past seven years. A robust rise in November employment further cemented those expectations.

    “On the one hand, higher rates would be positive as they would confirm the strength of the U.S. recovery. But higher rates would inter alia increase interest expenses for corporates,” the BIS report said.

    In contrast, European Central Bank (ECB) beefed up its stimulus efforts at its Dec. 3 meeting, although a reduction in its already negative deposit rate and six-month extension of its bond buying program, was less than financial markets had hoped for.

    Amid expectations for additional easing by ECB, about 2 trillion euros (US$2.18 trillion) in sovereign debt in the eurozone trades at a negative yield, noted Borio, a new peak for that figure.

    In addition, the looming divergence between Fed and ECB policy has weakened the euro’s exchange rate. Although the euro rose following the ECB’s meeting Thursday, at just under US$1.09 late Friday is was still considerably lower than its level one year ago.

    As a result, there has been a rise in euro-denominated borrowing from outside the eurozone, according to BIS statistics. When that currency weakens, it makes it easier for the debt to be serviced in the local currency that is appreciating.

    “What is perhaps new is that the euro seems to be taking on the attributes of an international funding currency, just like the dollar,” said Hyun Song Shin, BIS’s head of research.

    “Cross-border bank lending in euros to borrowers outside the euro area shows the telltale pattern where a depreciating euro goes hand in hand with greater euro-denominated lending to borrowers outside the euro area,” he said. (SD-Agencies)