A "yin-yang" global economy has emerged with increasingly intertwined markets meaning that one country's monetary policy can have unintended negative consequences elsewhere, says Morgan Stanley chief international economist Joachim Fels.
For example, the stronger dollar and rising U.S. interest rates, a side-effect of expectations that the Federal Reserve will soon begin to taper its asset purchases, are weighing on emerging market economies with large current account deficits, he said in a note published on Sunday.
After the Fed indicated it was considering tapering in May, emerging markets went through a volatile period, with fund outflows tanking stock markets and weighing on local currencies. In August, India's rupee plunged to a record low of 68.8 against the U.S. dollar, but has since recovered somewhat to around 62.55.
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Japan's aggressive monetary stimulus meanwhile has had unintended consequences elsewhere, for instance by increasing deflationary pressures in the euro area, Fels said.
"Japan versus the euro area is another example of the yin-yang global economy," with the yen's sharp depreciation against the euro a side-effect of Japan's progress on overcoming deflation, he said. Yin-yang, a concept from Chinese philosophy, is used to describe how seemingly opposite forces are interconnected.
The Bank of Japan pledged in April to pump $1.4 trillion into the Japanese economy over the following two years, marking the world's most aggressive quantitative easing program, as the country aimed to break out of two decades of deflation.
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"This in turn has contributed to the increasing deflationary pressures in the euro area," Fels said.
"The attempt by Japan to 'de-Japanify' has, somewhat ironically, contributed to the rising risk of a Japanification of the euro area," Fels said. As funds flow out of Japan seeking higher returns elsewhere, the yen is weakening and the euro is strengthening as funds flow into euro zone markets.
A stronger euro is keeping inflation on the continent low, hurting the competitiveness of Europe's exports and limiting economic growth.