Since April, when the dollar finally shook off the stigma from America’s deteriorating fiscal outlook on the way to rallying behind hawkish Fed policy and a favorable shift in rate differentials, questions about the resiliency of emerging markets have popped up time and again.
“Monetary stimulus by the Fed and other advanced economies played a relatively limited role in the surge of capital flows to (emerging market economies) in recent years”, Jerome Powell said, at an IMF/SNB event in early May, before contending that “there is good reason to think that the normalization of monetary policy in advanced economies should continue to prove manageable for EMEs.”
While it’s too early to say whether Powell will proven definitively wrong, Q2 was the worst quarter for emerging market equities and FX since 2015. The Fed continued to tighten and seemed generally unmoved by the protestations of, for instance, the RBI’s Urjit Patel, who in an Op-Ed for FT suggested Powell should calibrate the pace of balance sheet normalization to account for increased Treasury supply or risk choking off liquidity to the rest of the dollar bond market.
On May 30, in “I Know You Want To, But Don’t Ignore This Out-Of-Cycle Wednesday Rate Hike“, we suggested folks shouldn’t discount the importance of Bank Indonesia’s inter-meeting hike. The move came less than two weeks after BI hiked for the first time since 2014, amid an acute slide in the rupiah, falling stock prices and rising bond yields. That move suggested new Governor Perry Warjiyo is pretty serious about staying ahead of the game. On June 6, he echoed the RBI’s Patel in warning the Fed to be cautious. Here’s what he told Bloomberg, in an interview:
We know every country must decide their policy based on domestic circumstances but look, you have to take account of your actions and the impact of your actions to other countries, especially the emerging markets.
Meanwhile, there were already signs of acute stress. Argentina found itself back in crisis, cracks were showing in Brazil, Russian assets were crushed in April amid U.S. sanctions and Turkey was already well on its way to the dark side as the lira weakened week after week with only intermittent bouts of relief as Erdogan consolidated power.
When the lira collapsed in earnest on Friday, all anyone could do was cross their fingers and hope the broader emerging markets complex would hold up under pressure. The problem, though, is that the dollar is seemingly caught in a self-feeding loop whereby the interplay of U.S. fiscal policy, the Fed and Trump’s tariffs are driving the greenback relentlessly higher. At the same time, the trade frictions threaten to undermine global growth and the Trump administration’s sanctions on Russia and Turkey have the potential to pile even more pressure on at a delicate time.
Given all of the above, it comes as no surprise that emerging market currencies came under enormous pressure to start the week as the lira continued to fall on the heels of a weekend that found a defiant Erdogan digging in for a protracted fight.
On Monday, Turkey’s central bank attempted to stop the bleeding with a series of announced steps aimed at supporting financial stability. Long story short, it didn’t work, but they pledged to “closely monitor market depth and price formations, and take all necessary measures to maintain financial stability, if deemed necessary”. “All necessary measures” other than a rate hike, of course, which Erdogan said Sunday he would sooner die than acquiesce to. The respite was fleeting and the lira quickly went back to trading well weaker than Friday’s worst levels.
The lira’s woes rippled across emerging market FX on Monday.The rand, for instance, was hit hard early and abruptly nosedived as Mrs. Watanabe was apparently stopped out.
jesus.. USD/ZAR JUMPS AS MUCH AS 10% TO HIGHEST SINCE JUNE 2016
— Walter White (@heisenbergrpt) August 13, 2018
If you frequent these pages, you probably know Nedbank’s Mehul Daya and Neels Heyneke. They’ve been pounding the table on dollar liquidity in the context of the rand for as long as I can remember and on Monday, they were out with a new note in light of the above. Here are a couple of excerpts:
The recent slide in the rand has little to do with local developments, instead as we have maintained throughout the year, it is all about the shrinking pool of Global $-Liquidity (see feature chart). The lack of market liquidity combined with emerging market contagion from Turkey and Russia is exerting downward pressure on the rand. The Turkish lira is under severe pressure, largely on the back of a central bank that lacks credibility and independence to act on run-away inflation. The weaker lira which has also seen Turkish bond yields much higher is threatening to erupt into a full-blown balance-of-payment problem as Turkey’s foreign reserves continues to decline. At the same time, the Russian ruble is sharply weaker as the US imposes more sanctions on Russia. The dollar is also stronger in its own right. US dollar strength is evident against the euro. The EURUSD is trading below the 1.15 level for the first time since July 2017.
For the rand to depreciate above R14.50 on a multi week/month basis we believe four factors need to materialize. Firstly, commodity prices need to decline sharply (we remain cognizant that the rand remains a commodity currency). Secondly, the credit cycle in China must weaken despite fiscal and monetary stimulus by the authorities. Thirdly, our Global $-Liquidity indicator must move into negative territory (it has merely slowed down lately) and lastly downside risks from the local economy must gain further momentum.
On Sunday evening, in our week ahead preview, we gently suggested that given heightened concerns around EM, it will be interesting to see what comes out of Bank Indonesia’s meeting this week. The current-account deficit widened to 3% of GDP in Q2, versus 2.2% in Q1, the bank said on Friday. The central bank has tried desperately to stay ahead of the game this year, but the rupiah remains under pressure. Well, despite consensus (which expects no change), they may need to hike this week, because the rupiah was down sharply on Monday as well, falling as low as 14625 to the dollar. That’s another “weakest since October 2015” moment for the currency.
BI, which has raised rates by 100bps since mid May (see linked post above), may need to hike by an additional 100bps by the end of the year should the situation in Turkey worsen or if the trade war escalates, according to a note by Ciptadana Sekuritas Asia’s Imanuel Reinaldo, who says the fact that the the current account deficit hit 3% in Q2 should be a “yellow” light for policymakers.
The bottom line on Monday is that this situation is far from “contained”. Turkey’s problems may be “idiosyncratic” (not every country is “lucky” enough to have an Erdogan), but Ankara isn’t the only one with a current account deficit and the external shock from ongoing Fed tightening is an equal opportunity drag across the EM complex.