EM tumble carries echoes of 1990s crisis

January 24, 2014 5:22 pm

EM tumble carries echoes of 1990s crisis

By John Authers

Fed, China and now Argentina send investors scurrying for cover

When the money keeps rolling out you don’t keep books,
You can tell you’ve done well by the happy grateful looks.

Evita, lyrics by Tim Rice

Argentina has been here before. So have many other emerging markets. For the second time in six months, money is rolling out. Emerging currencies are under acute pressure, as are bonds and equities.

But the important point about crises in emerging markets is that they do not start there. Instead, they are almost invariably triggered by the actions of investors or central banks in the developed world.

Emerging markets have made strides during the past two decades. With a few exceptions, they have let their exchange rates float, built the institutions needed for free-market capitalism, and developed local debt markets to cut reliance on foreign funds.

But certain truths remain. Flows of foreign capital still dwarf local money. While that money keeps rolling in, the temptation is to behave like a latter-day Eva Peron; and when that money rolls out, there can be problems.

Look at a historical precursor: the wave of emerging markets crises in the late 1990s that started with Mexico’s “tequila crisis”. It started in 1994 when the government gave up defending its peso at an overvalued level.

Mexico had been spending beyond its means. But the trigger for crisis came from the US, where the Federal Reserve that year raised rates sharply to head off inflation. That brought money home and revealed Mexican problems.

This week’s events fit the 1990s template, only now China has emerged as the world’s second economic superpower. Events there, as well as in the US, can send money scurrying for cover.

Argentina is a special case. Its debt was downgraded late last year, to reflect concern at the new economic team of the president, Cristina Fernández, so many institutions are barred from investing in it. It is no longer even considered an “emerging” market by MSCI, the guardians of the term for equity markets, so many equity investors cannot buy Argentina.

There is little reason why Argentina should affect others, beyond its neighbours.

Rather, the exit from emerging markets has been driven by renewed concern about the Fed. Talk that it would taper off its bond purchases, which kept US rates low and encouraged money to go overseas, last summer led to a sell-off in emerging markets.

When the Fed finally tapered, in December, it muted the effects with forward guidance that in effect promised that rates could not start to rise until 2015 at the very earliest. This week’s sell-off of emerging currencies came as traders worried that such “forward guidance” could not be trusted.

The fate of the forward guidance offered in August last year by Mark Carney, governor of the Bank of England, demonstrates the problem. He promised not to raise rates at least until unemployment dropped to 7 per cent; it has since fallen faster than expected, to 7.1 per cent; and so Mr Carney this week downplayed the importance of his guidance.

The message for traders: central banks can always retreat from guidance if they have to.

Then there is China. HSBC’s flash estimate of the ISM supply managers’ index this week suggested the economy was shrinking. Further, money market rates in China are spiking upwards, in a crude attempt by the authorities to bring credit under some control. And China faces a test case over whether it will allow defaults by trust loans, a form of shadow banking.

Faced with such concerns, US and western money headed home and into treasury bonds, which are now yielding almost exactly what they were when the Fed announced its taper in December.

Sentiment towards emerging markets tends to move in long waves. As the chart shows, developed markets have beaten emerging markets during the past 20 years, a period that starts on the eve of the tequila crisis – even though emerging markets have grown far faster.

Such waves of sentiment are hard to stop. This one could easily last longer.

Emerging markets funds have suffered persistent outflows for more than three months, according to EPFR data, without what BofA Merrill Lynch calls true “capitulation”. That would mean outflows of more than $20bn per week; the latest week saw an outflow of $2.4bn.

As for currencies, fair value measures kept by Deutsche Bank’s Alan Ruskin suggest that none has yet overshot, and that Brazil’s real is close to its 10-year average, after accounting for inflation.

In the long run, the well-rehearsed arguments for emerging markets remain good. They are likely to grow faster than the west, and do not look expensive. Those with a long-term horizon might well start dribbling money into emerging markets.

But the risks remain high that emerging markets assets will soon be cheaper still. That will depend largely on the Fed, and on China.

 

Last updated: January 24, 2014 2:29 pm

Emerging markets sell-off spreads

By Ron Derby and Robin Wigglesworth in London and Gillian Tett in Davos

Emerging market stocks have fallen sharply, tumbling to their lowest since July 2013 as investors took fright at a plunge in Argentina’s peso and wider volatility sweeping through financial markets amid concerns over Chinese growth.

The FTSE Emerging Markets index fell 1.2 per cent on Friday, extending this year’s slump to more than 4.7 per cent.

Fears over emerging markets have heightened since theUS Federal Reserve announced plans to scale back and eventually end quantitative easing this year. But those concerns have been compounded by worries over Chinese economic growth – a big driver for the developing world as a whole.

The movements in emerging markets have been “spectacular” this week, said Jane Foley, senior currency strategist at Rabobank. “Domestic fundamentals have come home to roost.”

As emerging market currencies took another dive, investors poured money into US Treasuries, the yield on 10-year US government debt falling to 2.73 per cent.

Turkey’s lira fell 1.6 per cent on Friday followingThursday’s heavy losses, with Russia’s rouble falling to its lowest level in almost five years against the US dollar.

South Africa’s rand slid to its weakest level since October 2008. Even Mexico’s peso, one of the stronger currencies in the developing world, declined for a fourth straight day to its weakest level against the US dollar since June last year.

Despite concerns over tapering and its impact on the developing world, Alexandre Tombini, the central bank governor of Brazil, insisted that his country had plenty of “buffers” to deal with any market turbulence.

“Tapering is a net positive for a country like Brazil,” he said, arguing there was no reason to fear that a shift in US monetary policy would hurt Brazil in any serious way. “This change of relative prices since (taper talk) started is part of the process [of normalisation].”

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The market volatility was triggered by a survey released on Thursday that indicated Chinese manufacturing unexpectedly contracted in January. That was followed by a nose-dive in the value of Turkey’s and Argentina’s currencies. The Argentina Peso had its biggest one day drop, down 14 per cent, on Thursday and continued its drop against the US dollar on Friday, weakening a further 1.7 per cent.

Of the 24 emerging market currencies tracked against the US dollar by Bloomberg data, only three, the Chinese renminbi, the Thai baht and Taiwanese dollar, were in positive territory.