Wednesday is a disconcerting day for emerging markets.
The narrative all year long has revolved around the extent to which flareups in Argentina and Turkey represent idiosyncratic, country-specific risks that do not necessarily have applications for the broader EM complex. That contention is debatable to say the least.
The outlook for developing market assets deteriorated meaningfully during Q1 when U.S. fiscal and monetary policy started to translate into a dollar funding squeeze. Although that subsequently abated, ongoing strength in the U.S. economy has kept the Fed on its toes when it comes to heading off the risk of overheating. Between hawkish Fed policy and the “trifecta” of USD+ policies (to quote BofAML) the Trump administration is running, the greenback has remained buoyant. That’s precarious for emerging markets.
So, there’s a strong argument to be made that Turkey and Argentina simply represented what happens when an increasingly challenging external environment starts to tip dominos. That is, “yes”, there are country-specific factors behind the collapse in the peso and the lira, but behind it all is a veritable sea change in global dollar liquidity dynamics.
The reason Wednesday is so disconcerting for EM is that Tencent’s miss is weighing heavily on the space on a day when the Turkish lira has stabilized and is rallying for a second straight day. The fact that EM was under pressure from the turmoil in Turkey and is now under pressure again despite that turmoil having temporarily abated, means that EM is vulnerable both to idiosyncratic, country-specific risk and to company-specific risks emanating from trouble in EM index heavyweights (Tencent is the biggest component of the MSCI EM gauge). That’s in addition to EM’s obvious vulnerability to broader macro risks, and on that front, this week’s activity data from China didn’t do much to shore up confidence.
A great example of how all of these factors can conspire to great decidedly negative outcomes is the South African rand. On Monday, the rand basically crashed following the lira’s ugly open. Here’s what Nedbank’s Mehul Daya and Neels Heyneke had to say on Monday morning:
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.
Well, the currency is down sharply again on Wednesday and there are a variety of factors at play. For one thing, commodities are getting hit (again).
(Bloomberg commodities index falls on Wednesday)
In addition to that, the rand is also digesting a downbeat assessment from Moody’s (which sees the country’s fiscal deficit coming in at ~ 4% of GDP in 2018-19, higher than the 3.6% government projection) and also the plunge in Naspers, which owns 31% of Tencent. This looks to me like the worst day for the shares since 2008:
Here’s a look at the week ZAR is having:
The fact that EM is having such a rough day is even more disconcerting when you consider Bank Indonesia’s rate hike. Although consensus was still calling from the bank to stand pat, it was readily apparent after the lira’s slide that this meeting was live. We said as much on Sunday evening:
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.
We said it again on Monday morning and then hours ahead of the decision, there was this:
Indonesia should probably hike.
— Heisenberg Report (@heisenbergrpt) August 15, 2018
Well, they did – hike that is – despite just seven out of 28 economists predicting it. That’s the fourth hike since May and it comes as the bank has intervened heavily on behalf of the rupiah amid the EM FX turmoil. The country is now resorting to import curbs to try and stanch the bleeding.
When you think about Wednesday’s hike from BI in the context of Argentina’s emergency hike earlier this week, it suggests officials are trying to stay on top of this. The fact that it’s not working is worrying. The EM equity ETF is down the most intraday since February and it wouldn’t take much to make Wednesday the worst day for the product since Brexit.
Consider that with what we noted on Tuesday evening in “To Spillover Or Not To Spillover, That’s The Question“:
Credit Suisse’s Mandy Xu was out on Tuesday noting that according to implied vol. on EEM, which is sitting right at its five-year average, traders aren’t pricing in much in the way of fear.