As emerging markets sink into bear territory, oil could be the tipping point

One trader says a key factor could trigger the next drop for emerging markets.

“It’s oil that could be the tipping point that could send everything tumbling down,” Boris Schlossberg said Wednesday on CNBC’s “Trading Nation.” It’s “going to create a very, very onerous balance of payments problem for them going forward especially if oil goes high.”

Emerging market economies pay for oil in U.S. dollars, meaning a high greenback against the local currency makes the commodity more expensive. The dollar recently hit a 13-month high against a basket of foreign currencies.

If crude oil can get back up to $70 and the dollar continues to strengthen against foreign currencies, the pressure will increase for emerging markets, said Schlossberg, managing director of FX strategy at BK Asset Management,.

“Those factors could really combine into a perfect storm for the market and have a very bad effect on us, because as emerging markets collapse that’s going to definitely have a spillover effect into G-20 territory,” he said.

An economic and debt crisis in Turkey has spooked emerging and developed markets in the past week. So far, G-20 economies such as the European Union, the U.S. and Japan have held up against the pressure, though global markets did see some heavier selling on Wednesday.

Rising fears of contagion are being reflected in the options market, though it might be worth the extra cost, according to Stacey Gilbert, market strategist at Susquehanna.

“The risk being priced into emerging markets on a relative basis to a small cap is off the charts,” Gilbert told “Trading Nation” on Wednesday. “Protection in both the S&P 500 as well as the Russell 2000 is well worth the investment for the potential for contagion. … I’d want to own downside puts. I’m not as interested in spreads. I want the ability for me to be able to get short.”

The EEM ETF is down 12 percent in 2018 and on track for its first negative year since 2015. Losses have escalated this month, dragging the ETF down to its lowest levels in more than a year.