Time is nigh, as emerg­ing mar­kets feel­ing the pinch

Financial Mirror (Cyprus) - - FRONT PAGE -

We are mere days away from the Fed­eral Re­serve’s very first in­ter­est-rate hike in over nine years. Such is the sig­nif­i­cance of this his­toric mon­e­tary pol­icy de­ci­sion that eq­ui­ties mar­kets, cur­rency mar­kets, in­dices and com­modi­ties are ner­vously jock­ey­ing for po­si­tion.

When­ever cen­tral banks like the Bank of Eng­land, the Euro­pean Cen­tral Bank, or the Fed make a de­ci­sion to raise or lower in­ter­est rates, the im­pact of such a de­ci­sion is pro­found. Since we are talk­ing about the world’s #1 econ­omy, the Fed­eral Re­serve Bank is the gold stan­dard. It is a fore­gone con­clu­sion that we can ex­pect a 25-ba­sis point rate hike this com­ing week, bring­ing the in­ter­est rate from 0.25% to 0.5%.

The im­pli­ca­tions of a rate hike are go­ing to be felt by emerg­ing mar­ket cur­ren­cies, risky as­sets and global eq­ui­ties. The ra­tio­nale be­hind th­ese as­sump­tions is clear: when the Fed moves to raise in­ter­est rates, the USD ap­pre­ci­ates rel­a­tive to a bas­ket of cur­ren­cies. This is true of ma­jor and mi­nor cur­ren­cies. Since the yield on dol­lar-de­nom­i­nated as­sets, in­vest­ments and fixed in­ter­est-bear­ing as­sets will be in­creas­ing, there is a move to­wards th­ese par­tic­u­lar as­sets. In other words, cen­tral banks around the world will be buy­ing dol­lars, spec­u­la­tors will be buy­ing dol­lars, cur­rency traders will be buy­ing dol­lars and as the dol­lar is the world’s re­serve cur­rency, the over­all de­mand for the USD will in­crease. This nat­u­rally leads to an ap­pre­ci­a­tion of the green­back and a con­comi­tant de­pre­ci­a­tion of other cur­ren­cies.

How­ever, the im­pact is not sud­den. Much of the strength we are cur­rently see­ing in the USD has al­ready been fac­tored in to the im­mi­nent rate hike. This is also true of eq­ui­ties mar­kets. How­ever, we are go­ing to see an ac­cel­er­a­tion of cap­i­tal flight from risky fi­nan­cial as­sets such as de­vel­op­ing coun­tries (emerg­ing mar­ket economies) and their cur­ren­cies. Th­ese in­clude par­tic­u­larly vul­ner­a­ble cur­ren­cies like the South African Rand which is now trad­ing at over 15:1. Other cur­ren­cies likely to take a hit in the com­ing week are the Turk­ish lira, the Brazil­ian real, the Rus­sian rou­ble, the Chi­nese yuan, the In­dian ru­pee and other EM cur­ren­cies.

There are also in­di­rect con­se­quences for a Fed rate hike on emerg­ing mar­ket economies, and th­ese will be felt in the ar­eas of the MSCI emerg­ing mar­kets in­dex, emerg­ing mar­ket econ­omy funds and global eq­ui­ties. It has al­ready been es­tab­lished that de­vel­op­ing economies have en­dured the long­est de­cline since June on the back of US Fed rate hikes. There are real fears that cap­i­tal out­flows will ac­cel­er­ate mid­way through De­cem­ber.

Owing to the strate­gic plans of min­ing com­pa­nies to re­duce pro­duc­tion mov­ing for­ward, in­dus­trial met­als prices have risen. How­ever, the per­sis­tently low price of Brent crude oil, which has now faced in­creas­ing down­ward pres­sure as a re­sult of OPEC’s re­cent de­ci­sion is now push­ing the $36 sup­port level. We are see­ing a shift in in­vest­ment in­come from eq­ui­ties mar­kets and funds to fixed in­ter­est-bear­ing ac­counts such as Trea­suries, bonds and sav­ings ac­counts. This is be­ing done in an ef­fort to com­bat in­fla­tion­ary pres­sures which are likely com­ing as a re­sult of the Fed rate hike.

Global fi­nan­cial mar­kets are now fac­ing in­creas­ing volatil­ity es­pe­cially in the days lead­ing up to the Fed’s de­ci­sion. There is tremen­dous ac­tiv­ity in terms of sell­offs with eq­ui­ties, and this is bound to con­tinue through­out De­cem­ber.

Al­ready, com­mod­ity prices are at 16-year lows, fu­elled by per­sis­tent weak­ness in the Chi­nese econ­omy. Just last week, the S&P 500 in­dex capped a 3% de­cline, and there are con­cerns that China weak­ness will per­vade global mar­kets.

One of the most im­por­tant mea­sures of mar­ket volatil­ity is the Chicago Board Op­tions Volatil­ity In­dex (VIX). It recorded a 45% in­crease in volatil­ity to 21.55 – the high­est fig­ure in al­most four months. This is one of the most im­por­tant gauges of over­all mar­ket sen­ti­ment, and the higher it is the more bear­ish the out­look for stocks. Some of the weak­est sec­tors in the mar­ket are com­modi­ties such as cop­per and iron ore, as well as crude oil.

Emerg­ing mar­ket cur­ren­cies are par­tic­u­larly vul­ner­a­ble, no­tably the 20 de­vel­op­ing na­tion cur­ren­cies which plunged 1.9% for the week – the worst per­for­mance in three months. How­ever, as one might ex­pect, the losses felt by emerg­ing mar­ket cur­ren­cies trans­lated into gains felt by the USD in the US dol­lar in­dex.

One of the big­gest losers in the run-up to the Fed rate hike is the MSCI Emerg­ing Mar­kets in­dex. A 4.4% de­cline for the week end­ing Fri­day, De­cem­ber 11, marked one of the worst per­for­mances since Septem­ber. Other eq­uity bench­marks that de­clined sub­stan­tially in­clude South Africa, Hong Kong and In­done­sia.

Of course, the big­gest faller of the week was oil. It is now gen­er­ally ac­cepted that the oil price will re­main vul­ner­a­ble, weak and de­pressed through­out 2016. WTI crude dropped as low as $36.43 per bar­rel as per­sis­tently bear­ish in­vestor sen­ti­ment dom­i­nates the crude oil mar­ket. All in all, the Fed rate hike is go­ing to have a mixed re­ac­tion on global mar­kets, but the good news is we can ex­pect a sub­tle and grad­ual in­crease in rates as op­posed to a sharp and sud­den rate hike.

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