EM angst heightens on new Brazil scandal
A new corruption scandal in Brazil compounded investor anxiety over emerging markets that have enjoyed a bullish run this year. Along with the slump of nearly 8 per cent in the real, today’s falls in the South African rand and Mexican peso underlined how quickly market sentiment can shift for the sector.
“EM FX is succumbing to the growing risk-off sentiment in the markets,” said Win Thin at Brown Brothers Harriman.
The real weakened to R3.38, after a report in a leading Brazilian newspaper embroiled president Michel Temer in bribery allegations, putting his reform agenda in jeopardy.
One-month implied volatility on the currency — a gauge of how much money investors are willing to pay to insure against the real’s swings over the next 30 days — surged more than 70 per cent.
More broadly, EM forex was undermined by markets becoming unsettled by unease over China, as well as US economic prospects in relation to Donald Trump’s troubled presidency.
Dollar declines normally benefit EM currencies as investors seek out highyielding assets, but Kamakshya Trivedi of Goldman Sachs said risky assets such as EM were coming under pressure from “a classic volatility shock”.
The latest Brazilian scandal was “a reminder of political risk that is a feature of EM i nvesting”, Mr Trivedi added.
Political developments in Brazil were “adding fuel to the fire” in EM, said Mr Thin, while the peso’s fall suggested that it was being used as a proxy for general market sentiment towards EM.
The peso’s decline came amid expectations that the US would send formal notification to Congress that it was negotiating the North American Free Trade Agreement, triggering the start of talks with Nafta partners Canada and Mexico.
Ci t i g r oup a nalysts trimmed their exposure to long EM forex positions. “As much as we believe the degree of panic in the market is exaggerated, there is now a clear crescendo i n the amount of noise in the markets,” they wrote.
Market noise is rising around the reflation trade because of creeping doubts about growth in China and the US. Global growth was seen as “a good thing” for EM, said Jane Foley at Rabobank, even if that meant rising interest rates in the US that tend to drive EM forex lower.
“But if you’re hiking interest rates against the backdrop of more wobbly data, it’s more difficult to pass that off as a positive thing for emerging markets,” MsFoley said.
China was causing concern about the size and pace of debt, the lack of jobs growth in the private sector and slowing commodity purchases. “China is the biggest consumer of commodities, so any sniff does feed back to the EM world quite quickly,” Ms Foley said.
Investors should remind themselves that current risk aversion did not alter improving macro fundamentals in EM, Mr Trivedi said.