Dollar surge bringing emerging market rate cut cycle to a halt
LONDON: A resurgent dollar and higher borrowing costs are smashing through Argentina and Turkey’s currencies like a wrecking ball and raising the likelihood more broadly that emerging markets’ three-year long interest rate cutting cycle is at an end.
Emerging markets came into the year flying, riding on the back of a healthy global economy and rising commodity prices alongside tame inflation and a weak dollar.
It looked more than likely that a wave of rate cuts would keep rolling, allowing a bond rally to continue.
From Brazil and Russia to Armenia and Zambia, developing countries, big and small, have been on a rate cutting spree.
With hundreds of rate cuts since Jan 2015, the average emerging market borrowing cost fell under 6 per cent earlier this year from over 7 per cent at the time.
Fund managers’ profits too have soared in this time, with emerging local currency debt among the best performing asset classes, with dollar-based returns of 14 per cent last year. Even in the first quarter of 2018, returns were a buoyant 4.3 per cent.
Now though, almost exactly five years since the so-called taper tantrum shook an emerging market rally, these gains appear to be on the cusp of reversal.
Argentina has jacked up its interest rates to 40 per cent in response to a rout in its peso currency, while Turkey was also forced into a rate rise as its lira hit record lows against the dollar. Indonesia, after heavy interventions to stem rupiah bleeding, has also said it could resort to policy tightening.
As emerging currencies slide almost everywhere, yields on bonds denominated in emerging market currencies are back up near 6.2 per cent and returns are now negative for 2018
“The rate cut trade has unwound,” Naveen Kunam, a portfolio manager at Allianz Global Investors said, citing the increased uncertainty on monetary policy. For decades, a rising dollar has spelt bad news for emerging markets and despite all the progress in the developing world in recent years, latest price moves show not that much has changed.
With the dollar on the rise, emerging currencies have weakened some 3 per cent in the past two weeks, as measured by a JPMorgan index. Figures from the Institute of International Finance this week showed that the result has been a faster exodus from EM debt than at a similar stage of the 2013 taper tantrum.
At US$5.5 billion in two weeks the IIF described it as the “ghost of tantrums past”.