Politics, Fed could whip up new emerging markets storm

Politics, Fed could whip up new emerging markets storm

Fri, Feb 14 2014

By Natsuko Waki

LONDON (Reuters) – A stabilization in emerging marketsafter January’s rout may turn out be the calm before the storm if political flare-ups and Fed policies provide the spark for the next round of selling.

Currencies in Turkey, South Africa, Hungary and Russia, which suffered violent sell-offs over the past month, have recovered slightly, partly because central banks have fought back via interest rates hikes or exchange rateinterventions.

Investors also appear more sanguine about the U.S. Federal Reserve’s plan to steadily withdraw monetary stimulus, a stance confirmed by its chair Janet Yellen this week.

But the next stress points are already emerging.

Some investors are bracing for the “April tipping point”, when the Fed’s stimulus withdrawal in real terms is expected to start having a more material impact on the economy.

“Another catalyst will be political uncertainty, with many of the deficit countries facing elections in 2014,” said Gautam Chadda, director of investment consulting at RBC Wealth Management.

That includes the capital-hungry “Fragile Five” countries, voters in all of which are due to pass judgment on their governments this year.

“Markets don’t like uncertainty and there is a lot of political uncertainty out there,” said Chadda, who expects pressure on emerging markets to return as the Fed scales back its asset-purchases over the course of the year.

And if turbulence has ebbed in markets such as Turkey and India, it appears to be spreading to other parts of the developing world.

For instance, markets in commodity exporting Nigeria, which is sensitive to China’s growth and until recently a top frontier market investment destinations, have tumbled.

The naira has hit two-year lows after President Goodluck Jonathan sacked four cabinet members ahead of next year’s general election, and its weakness has been only partly stemmed by central bank intervention.

A weaker currency worsens the inflation outlook for Nigeria which depends on imports for almost 80 percent of goods sold in the country.

The cedi currency of another African commodity exporter Ghana, has also fallen to record lows.

FALLING RESERVES

Nigeria is also an example of an emerging economy that is seeing a steady depletion in its hard currency reserves – its cash pile has fallen 7 percent over the past year.

Reserves fell in 11 out of 17 key emerging economies, including Russia, South Africa and Indonesia, in the year to January, as once-buoyant investment inflows dwindle and trade with a slowing China declines.

That in turn undermines the ability of central banks to support currencies under pressure.

Michael Howell, managing director of CrossBorder Capital, said recent poor economic data out of China is a reminder for investors of the sensitivity of many emerging markets to the world’s second-biggest economy.

“Is the crisis over? It’s not. Real exchange rates of emerging markets have to come down further,” Howell said.

“Which banana skin are you going to slip on? I believe it would be weak economic data coming out of China or signs of FX reserves to start falling significantly.”

He noted that Britain and the United States had recovered faster from Great Depression in the 1930s than France, which prioritized monetary discipline.

That could set the stage for a round of beggar-thy-neighbor competitive currency devaluations in emerging markets. Kazakhstan may already have started it, with its 19 percent tenge devaluation this week.

That move was motivated by weakness in the rouble of Russia, Kazakhstan’s key trade partner.

“The shining lesson from the 1930s is that those countries that devalued currencies first got out quickly. (Kazakhstan) is following the script,” Howell said.

TIPPING POINT

The Federal Reserve’s winding-down stimulus, which began in December, has so far not significantly driven up U.S. bond yields, which remain below levels seen in May-June last year.

But it may simply be that the real effect of tapering has not kicked in yet, because as the economy recovers and the U.S. budget deficit shrinks, the Treasury is issuing less debt.

Stephen Jen, managing partner of SLJ Macro Partners says that until the Fed’s monthly bond-buying falls below $55 billion, tapering will not have a real impact, relative to total bond sales.

“The Fed’s tapering will only catch up to the Treasury’s tapering by April or so,” Jen said. “This may help explain why equity prices have been so well supported in Q4 2013 and early 2014, despite the Fed’s decision to taper.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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