Sunday, June 23, 2013

Emerging markets for sale

Floating emerging markets currencies have been under tremendous pressure over the past month, as active investors move out.  Slowing growth, political instability, and weaker demand for natural resources have all contributed to the sharp declines. Rising rates in the US have not helped the situation either, making the dollar more attractive on a relative basis.

Not to be outdone, the Australian dollar - which is sometimes used as a proxy currency for China - is also down 6.4% over the same period. Many Emerging markets currencies have not seen these levels since the financial crisis. The Indian rupee touched another all-time low of 59.57 to the dollar. As discussed earlier, Brazil has been hit the hardest. The situation would have been considerably worse if the governments didn't actively intervene in the currency markets.

Nations with pegged currencies are also not immune to flight of capital. Argentina for example is experiencing tremendous pressure on foreign reserves.
Credit Suisse: - [Argentina's] central bank’s reserves remain under pressure. Gross foreign reserves have declined $5.0bn ytd to $38.3bn, compared to a $0.1bn increase over the same period in 2012. ... Reserves could fall by nearly $8.0bn this year. ... Any additional increase in reserves related to the tax amnesty program carried out in 3Q (perhaps $2.0-3.0bn) will likely be temporary and counterbalanced by external debt payments. Overall, we expect more controls to target deteriorating external imbalances, but reserves could still fall to $35.5bn by year-end and by another $5.0bn in 2014.
Anecdotal evidence suggests that China is also becoming concerned about capital flight. As a data point, the stock market is down some 10% over the past month. Some have even proposed that the high short-term rates in China (see post) is an attempt to "punish" those trying to short the currency (high rates and difficulties borrowing would make it hard to stay short the yuan).

Whatever the case, active investors are dumping emerging markets equities and bonds with the intensity not seen since the financial crisis.
JPMorgan: - EM bonds have been at the center of the flight from carry and illiquidity. EM local markets lost 1.5% FX-hedged, and almost 4% in USD terms Thursday, the former a record, the latter the worst day since October 2008. EM bond funds continue to see outflows, if more from hard currency than local currency funds. FX weakness is tilting risks toward tighter monetary policy to support the currency is some markets, and this week we penciled in another 50bp of hikes in Brazil. We maintain a short duration stance in EM, with position squaring likely still not done.
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