Asset Management & Market Research

“Eye of the storm is directly above emerging markets"

“The eye of the storm is directly above emerging markets now, two years after it hovered over Europe and four years after it hit the U.S.. This could be serious for Asia.” This from Stephen Jen, co-founder of hedge fund SLJ Macro Partners LLP in London and former head of foreign-exchange strategy at Morgan Stanley, in a Bloomberg piece yesterday.

The chart below, courtesy of Societe Generale (hat tip to Business Insider), provides cogent evidence of the capital flight out of emerging markets since May 1. It shows 19 currencies against the USD since May 1. Not only are EM currencies under severe pressure, but you see strength in the Euro, Swiss Fran and British pound.

currencies vs USD since May SOC GEN !!!!!!!!

 

The prospects of tapering and higher rates here in the US continue to have ramifications around the globe. Emerging markets continued to be roiled by capital flight and depreciating currencies, as carry trades are unwound and capital returns to the US.

Indonesia’s plight highlights the problems triggered by rising rates in the US, where the 10-year UST hit 2.90% Monday (recall it was below 1.6% in late April). Indonesian shares were down over 3% Tuesday after sharp declines Monday, and are flirting with bear market territory having slumped around 20% from their highs in May.

The problem? As rates have risen here, capital has flowed out of several emerging markets due to worries about slowing economic growth, exposure to China (whose economic slowdown curbs demand for commodities and goods in several emerging markets), and problems tied to a declining currency (higher inflation being one). This scenario prompts central banks to raise rates to counter capital flight and inflation.

Emerging markets from Brazil to Indonesia have raised interest rates in 2013 to try to aid their currencies as the prospect of reduced U.S. monetary stimulus curbs demand for assets in developing nations. India is struggling to stem the rupee’s plunge, attract capital flows to bridge a record current account deficit and revive growth. The currency has weakened about 28 percent versus the dollar in the past two years. Bloomberg notes that the currency crisis in India revives memories of the early 1990s crisis, when the government received an International Monetary Fund loan as foreign reserves waned.



Author: Craig Dougherty

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