Emerging market contagion in focus
ANALYSTS EXPECT VOLATILITY THIS MONTH AMID FEARS FOR EMERGING CURRENCIES, TRADE TARIFFS, DOLLAR CRUNCH
Sell-offs in emerging market currencies and concerns about contagion into equity markets are expected to take the spotlight this week, together with concerns on the ever-growing trade tariffs against China.
Analysts said they expect to see volatility in markets this week, and throughout September, which has historically been a volatile month.
Hussein Sayed, chief market strategist at FXTM, said traders are waiting to see whether Emerging Market (EM) currencies – namely the Turkish lira, Argentine peso, Indian rupee, and Russian rouble — will stabilise or not.
“I think these currencies are driving the market – whether it’s equities or fixed income, so they’re moving all kinds of asset classes,” he said.
While investors initially said the depreciation in the Turkish and Argentine currencies was both related to domestic issues within those countries, selling activity eventually spread to other EM currencies, and then to their equity markets.
On Thursday, the MSCI emerging market index traded 0.13 per cent lower after hitting a low of 1,018.46, nearing the lowest level since July 2017. The index recovered some losses on Friday, but was still trading at its lowest levels in over a year.
“It’s clearly not just a concern with one market; it’s the whole economy being a concern. If you look at European equity markets, all of them were falling last week, with some falling heavily. If we saw more crises in these markets, it’s not going to be contained in EMs; it’s going to spread to developed markets,” Sayed said.
Concerns on US policies
On top of EM-related concerns, there are still worries about US policies regarding trade tariffs and the ongoing dispute with China, he said.
Charles-Henry Monchau, managing director and chief investment officer at Al Mal Capital in Dubai, said the American mid-term elections (in November) could see President Donald Trump dial up the pressure on China to appeal to his base.
“We expect September to be volatile because historically, September has been a volatile month, and this is especially the case when there are midterm elections in the US,” he said.
“Then, there will be most likely very interesting buying opportunities either in October or November, but we believe there is still more pain to come before we do see a trough.”
Monchau also highlighted another key concern; dollar shortage, which he said is currently happening due to the Federal Reserve’s tightening at the time the US is issuing a lot of bonds.
The exchange rate vulnerability of emerging markets often comprises many factors ranging from domestic economic conditions, direction of portfolio investment flows and a large number of external factors such as trade barriers and relative strength of the US dollar.
According to the Institute of International Finance (IIF), in the run-up to this sell-off, for example, Argentina’s peso and the Turkish lira had markedly different trajectories, with the peso unwinding a previous appreciation, while the lira continues a trend depreciation that has been ongoing for many years.
“At this stage in the EM selloff, the lira and peso have depreciated more than needed to offset macro imbalances and are undervalued,” the IIF said in a recent note. “Indeed, in other cases where currencies were overvalued — India and South Africa — nominal depreciation has shrunk the misalignment to essentially zero.”
Analysts see the severity of recent market moves has increased anxiety over possible contagion and here are a few markets to look out for.
Turkey
The sharp devaluation of the Turkish lira following a series of unconventional macroeconomic policies and monetary policy decisions has seen the currency plunging more than 40 per cent year to date and sending the shock waves through global financial markets spreading a spectre of contagion across emerging markets.
Heightened political tensions between the US and Turkey have clearly weighed on investor appetite for emerging market assets. Economists and market analysts fear that the reverberations of the Turkish crisis, felt across many emerging markets, will have longer than expected consequences on their currencies, asset classes and investment flows.
Argentina
Argentina, reeling from its worst currency crisis in 17 years, has seen the peso falling more than 60 per cent this year to become the worst among the emerging market currencies.
In a desperate bid to support the currency and the economy, the country recently appealed to the developed world to ditch the rule book and buy the sovereign debt of emerging markets as part of their reserves. Argentina is in talks to speed up disbursement of money from a record $50 billion (Dh183.63 billion) credit line with the IMF. The peso’s decline worsened amid concern about the government’s ability to finance itself during the second recession in three years. The central bank raised the key interest rate to 60 per cent last week to curb rampant inflation.
India
India’s rupee has been in free fall since the beginning of this year, declining 12 per cent to become the worst performing Asian currency. While macroeconomic fundamentals of the country can’t be blamed to a great extent for the woes of the rupee, it is a fact that a confluence of external factors has hammered the currency.
For India, excessive dependence on oil imports is its Achilles heel in forex management. Crude prices have risen from $65 to $80, ever since US President Donald Trump decided to cancel the Iran nuclear deal.
India imports 70 per cent of its crude requirements and any rally in crude inflates the import bill and impacts the currency as well.
Indonesia
Indonesia is the largest economy in south-east Asia and has approximately 40 per cent of its debt denominated in foreign currencies.
Last week the rupiah, Indonesia’s currency, fell to its weakest level since the 1998 Asian financial crisis, having lost 10.5 per cent against the dollar since the start of this year. Indonesia’s central bank has hiked interest rates four times since May and intervened heavily in a bid to shore up the rupiah.
Brazil
Brazil, headed for its presidential election next month, is facing a huge currency crisis as the real plunged close to 30 per cent this year as the Latin American economy continues to reel from its worst-ever recession.
South Africa
The rand, down 24 per cent a year to date, fell sharply last week as newly released data showed that South Africa’s economy fell into recession last quarter for the first time since 2009.
Russia
The Russian rouble continues to decline, as the dollar continued to gain substantial ground against the emerging market basket of currencies. Geopolitical pressure related to the resumption of discussion of the bill on new US sanctions against Russia may give bearish sentiment for the currency this week, together with possible oil price correction. The rouble’s year-to-date loss against the greenback is more than 17 per cent.