Yeah, so emerging markets.
There’s some trouble there. If you’ve been following along, you know that the cracks are starting to show as the dollar surges and as traders begin to reassess the outlook in light of a Fed that looks like it might try to squeeze a total of four hikes in this year.
What was a global growth story is starting to morph into a narrative that centers around a late-cycle U.S. economy that’s likely to stay afloat perhaps longer than it should (this week, the current expansion in the U.S. became the second-longest in history) on the back of fiscal stimulus while the rest of the world decelerates. That fiscal stimulus is contributing to inflation worries stateside and those inflation worries are prompting the Fed to remain steadfast in their commitment to the rate path. That commitment is further underpinning the dollar which is once again correlated to rate differentials, creating a kind of self-feeding dynamic that’s not great news for emerging markets (or for a lot of other consensus trades for that matter).
Yesterday there was all manner of drama, as the lira plunged to a record low amid soaring inflation ahead of snap elections and concerns that Erdogan won’t let CBT do what’s necessary to stop the bleeding. That got materially worse on Friday as the currency hit another record low:
According to just released data from CBT, the CPI-based REER index fell to record low of 81.71 last month, down from revised 83.48 in March.
It looks like they may have to resort to an emergency rate hike just weeks after the 75bp hike to the late liquidity window failed to calm markets.
“Allowing the lira to fall precipitously would not only prolong the period of a double-digit inflation, it could also negatively affect sentiment with households and companies, potentially leading to a sharp economic slowdown,” Rabobank’s Piotr Matys said Friday, adding that “to halt this dangerous cycle that could accelerate in the current global environment dominated by a more cautious approach towards risky assets due to a strong U.S. dollar, the central bank may have to act quickly and decisively.”
Speaking of emergency rate hikes, Argentina has hiked twice in the space of a week in a truly desperate attempt to shore up the peso. We talked about that on Thursday. Those century bonds are all to hell:
Clearly some of this represents idiosyncratic risk playing out – remember, EM is always fraught with idiosyncratic risk. That’s part of why you get compensated more to invest.
Oh, and don’t forget about Indonesia, where the central bank may be hamstrung in its efforts to support the currency by the fact that hiking rates could end up curtailing consumption. Indonesian equities plunged for second day to new 7-month lows and as you can see, this is starting to get really dicey:
But the worries are broad-based. The EM ETF saw outflows of more than a half billion on Tuesday, the worst single-day exodus in more than a year and Wednesday it hemorrhaged an additional $300 million. EM currencies are on pace for a fifth weekly decline – that’s the longest stretch since August 2015. The MSCI stocks index is sitting near its lowest level since December 22:
All of this against a backdrop where U.S. -China trade talks ended without a concrete resolution and ahead of U.S. payrolls. Whether or not the latter adds to the pain for EM by reinforcing the recent Fed narrative or not, the setup is worth noting and for that, we’ll leave you with Bloomberg’s Mark Cudmore:
There will be a lot of nervous EM FX traders across London right now. The vast majority of strategy notes I’ve seen this week have recommended buying the dip across a variety of EM currencies. Now, all those traders who heeded such advice will be feeling very nervous knowing that they are approaching a binary risk-event in the NFP data. They’ll be feeling ill and cursing themselves that they didn’t have the discipline to already stop out from a tactical trade that’s gone wrong, yet not wanting to pull the plug just yet as many EM currencies are approaching extremes on the week. All those traders are wishing for now is enough of a rally that they can cut their position without too much pain before the data this afternoon. And it’s because the majority of the market is in that same position that EM FX will continue to grind weaker as the marginal trader gives in and cuts before the data. By lunch-time today, there’ll be a lot of EM FX traders in a bad mood. The ones who will be most upset are the ones that are still long into the data, which is why the afternoon trading could get messy if payrolls undermine EM. I’m nervous just watching — I’ve been in that position before.