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.

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