Back in May, when it was readily apparent that emerging markets had succumbed to a combination of external pressure (from Fed tightening, a stronger dollar and rising U.S. rates) and jitters tied to idiosyncratic, country-specific risk (e.g., central bank credibility issues in Turkey and Argentina), the big names started to pile on.
Among those big names was Carmen Reinhart, who didn’t do emerging markets any favors when she suggested the situation was perhaps more fragile than folks realize. Specifically, here’s what she said on May 16:
The overall shape they’re in has a lot more cracks now than it did five years ago and certainly at the time of the global financial crisis. It’s both external and internal conditions. This is not gloom-and-doom, but there are a lot of internal and external vulnerabilities now that were not there during the taper tantrum.
That same day, Mohamed El-Erian weighed in with this:
History reminds us that
higher oil prices+rising interest rates+appreciating dollar,
the trifecta that continues in #markets today (albeit not in an extreme fashion),tends to test the "self insurance" of several #EMergingMarkets ,together with their economic policy responsiveness pic.twitter.com/Jb1tTtgaU4— Mohamed A. El-Erian (@elerianm) May 16, 2018
Since then, the EM story has continued to be one of the key market narratives.
Emerging market equities and FX suffered through their worst quarter since 2015 in Q2 and outflows have been persistent and large.
For instance, foreign money is fleeing Asia EMs at the third fastest pace in 16 years:
The recent exodus wiped out 14 months of prior inflows, Goldman wrote last week.
Recently, the bank also took an in-depth look at what a “severe bear case scenario” would look like for EM outflows on the whole and what that scenario would likely mean for developing market equities, credit and local rates.
Now, there’s some disagreement between Wall Street’s largest banks as to whether this is a buying opportunity or simply an “opportunity” to cut your damn hand open trying to catch a falling knife. You can read a variety of opinions on that in “Who You Gonna Believe? Wall Street’s Biggest Banks Divided On Emerging Market Dip-Buying Call“.
Unsurprisingly, this debate is the subject of Goldman’s most recent “Top Of Mind” piece. Here’s the bank’s Allison Nathan:
There are plenty of reasons to worry about emerging markets today, from trade tensions to the historically painful combination of higher US rates and a stronger US dollar. The result? A striking shift in sentiment, and broad-based EM pessimism among many macro investors. But with many EM assets now at or near year-to-date lows, whether it’s time to re-engage–or prepare for further downside–is Top of Mind.
As a reminder, these are basically expansive takes on whatever the market topic du jour happens to be. They combine interviews with Goldman’s own employees and also with outside sources in an effort to provide a balanced and comprehensive assessment on whatever seems to be the most important question on market participants’ minds (hence “Top of Mind”).
One of the interviews in the EM edition is with Mohamed El-Erian and you can find a couple of short excerpts from his conversation with the above-mentioned Allison Nathan below.
Via Goldman
Allison Nathan: You seem pessimistic about the resilience of EM growth and assets today. But aren’t many EM economies stronger than they once were, e.g., during the taper tantrum?
Mohamed El-Erian: I wouldn’t label myself as a pessimist but rather as someone who respects market technicals. EMs have significantly strengthened their economic and financial resilience over the last several years. But market participants should not confuse fundamental resilience with technical resilience. The fact remains that the EM asset class is structurally imbalanced. The dedicated EM investor base is much smaller than the cross-over investor base, which means the “tourists” tend to overwhelm the “locals.” And when tourist capital flows into and out of EM economies, valuations tend to overshoot in both directions. In recent years, a tremendous amount of capital has flowed into EMs as foreign investors searched for yield amid exceptionally low rates in the developed economies. That capital is now exiting. US yields have been going up, risk aversion has generally increased, and the reputational risk for cross-over investors has risen as volatility has risen. So the key for EM investors as a whole is less the fundamental picture, and more the fact that the technical cycle has turned against them. These cycles are a classic EM phenomenon, and my gut feeling is we’re probably only halfway through this one.
Allison Nathan: Could the technical dynamics become selffulfilling by triggering a deterioration of EM fundamentals?
Mohamed El-Erian: It’s certainly possible. Think of it this way: For any given country, technicals represent the tail, while economic and financial variables represent the body. The tail should not wag the body; that’s why economic and financial resilience is so important. But if the body is too weak, that is precisely what may happen. Bad technicals may end up contaminating fundamental factors, which tends to happen most often when the currency overshoots. That’s something investors have already had to consider very carefully in places like Argentina and Turkey, for example.
Allison Nathan: The Fed clearly remains the other big risk for EM, and some EM policymakers have argued that the Fed should slow its policy normalization to temper the spillover effects. Will this enter into the Fed’s calculus?
Mohamed El-Erian: Officials from two countries in particular, Brazil and India, have consistently warned the Fed about the effects of quantitative easing (QE) and then quantitative tightening (QT) on EMs. These countries have been particularly focused on what I mentioned earlier: the tendency for QE to push more capital into the emerging world, and the tendency for QT to reverse that tide in a somewhat disorderly fashion. However, I don’t think this will enter into the Fed’s calculus unless we slip into a major global financial crisis, which is unlikely. I think the Fed’s view is that it must pursue its domestic dual mandate, and that any spillover effects should be dealt with by the affected countries. And the best way for EMs to deal with these effects is to get their house in order.
