Out Of The Woods? At The Crossroads Of An Emerging Market Crisis

I’d wager there will be more than a few stories written over the next several days about how the combination of a cooler-than-expected August CPI print in the U.S. (Thursday), a larger-than-expected rate hike from the Turkish central bank (Thursday) and a surprise rate hike from Russia (Friday), are all signs that the situation for developing economies could stabilize. [So there’s some weekend homework for the financial journalists out there – I’ll send you your next assignment once you deliver on that one]

After all, the CPI miss takes some of the pressure off the Fed at the margins and the rate hikes from Turkey and Russia suggest that EM central banks are indeed serious about getting out ahead of further dollar strength and unpredictable U.S. foreign policy. Still, rate hikes may not be enough if the dollar continues to rise. After all, Bank Indonesia has been hiking regularly since May, largely to no avail. Here’s the policy rate plotted with the weakening rupiah:



It will be interesting to see the latest positioning data on the spec dollar long. In the week through Tuesday, September 4, that position was trimmed by $2.6 billion. That was the second week in a row the position was pared, but it’s still stretched:



Jeff Gundlach thinks that’s likely a contrarian indicator and in his latest state-the-obvious-a-thon webcast, he suggested that if the dollar were to take a breather, it would help reverse the dramatic decoupling between U.S. stocks and the rest of the world.

This week, the dollar has come off pretty handily, with Thursday’s gains in the euro contributing alongside the cooler CPI print. Retail sales missed pretty handily on Friday which, all else equal, should put more downward pressure on the dollar.



Meanwhile, emerging market FX has performed well, a much needed reprieve following the deluge of negative headlines that came calling from August 28 through September 5 (e.g., renewed pressure on the Argentine peso, recession in South Africa). Here’s the JPM EM FX index on the week:



And here’s MSCI’s gauge:



Notably, the ratio of EM FX vol. to G7 FX vol. has come down with the dollar. That ratio had hit multi-year highs. Bloomberg had a good piece on this today. Here’s a chart that pans out a bit further than the one in that linked post:



For Goldman, EM now has a potentially adequate “yield cushion”, which the bank says could support the space going forward.

“Real 2-year rates (adjusted by 12-month forward inflation expectations) are up ~65bp since February this year (excluding Turkey where rates have spiked), which is the sharpest re-tracement since the 2013 Taper Tantrum (when they rose 99bp, ex-Turkey)”, the bank wrote, in a note dated Thursday, adding that “despite US 2-year rates also moving higher over the year, the EM-US real 2-year rate differential has widened by roughly 40bp since mid-April, meaning that the relative cushion now appears more supportive in EM.”



All of the above (i.e., a couple of negative surprises from the U.S. economy with CPI and retail sales missing, rate hikes from Turkey and Russia, and rising real rates) suggest stabilization might be in the cards. There are more key EM central bank meetings on the horizon, and they’ll be watched closely. Here’s Barclays from a note out Thursday:

In terms of monetary policy decisions amid recent currency volatility, in Brazil we believe the BCB will keep its current framework and not respond with any monetary policy action at its Copom meeting on September 19. The board has repeated that its next steps will depend on the evolution of economic activity, the balance of risks and the outlook for inflation. Economic activity remains lacklustre in 3Q, with inflation expectations well anchored. The balance of risks crucially depends on the outcome of presidential elections, and we do not see the bank reacting to electoral polls in the meantime.

South Africa’s inflation trajectory has deteriorated since the July MPC meeting. The currency is weaker, oil prices are higher and maize futures prices have risen, suggesting that food inflation could be on the rise in the coming months. At the same time, economic growth is contracting, with very little evidence of demand-pull pressures. The currency also appears to be getting some reprieve from the decisive policy action in Turkey. As a result, we expect the MPC to refrain from raising the policy rate at this meeting, although it is likely to prepare the market for a possible hike in the period ahead if the situation deteriorates further or if signs of rising FX pass-through emerge.

Despite all of this, it’s still unclear that emerging markets are out of the woods. Trade escalations have played dollar positive since April and U.S. foreign policy is becoming more unpredictable seemingly by the day. In almost all cases, that unpredictability has a positive read-through for the dollar.

What’s needed here are convincing signs that the U.S. economy is losing momentum and/or some kind of dovish lean from the Fed. In the absence of that, it seems just as likely as not that the market will continue to oscillate between fleeting bouts of dollar weakness and a renewal of greenback strength, with the latter continually chipping away at fragile EM sentiment.

On that note, we’ll leave you with SocGen’s take on who’s most vulnerable, although really, you should already be well apprised of this.

To assess vulnerabilities across emerging markets, we examine external positions, short-term external debt, foreign currency-denominated debt, fiscal and debt positions, reserve adequacy, and foreign bond ownership. A scorecard of gross (i.e. total number of indicators that suggest high vulnerability) and net (the summation of negative, neutral, positive vulnerability factors) vulnerabilities sheds light on which currencies might experience additional stress as the Fed continues to tighten monetary policy or if other factors impair EM sentiment.

  • High vulnerability: Turkey, South Africa, Malaysia, India, Indonesia.
  • Medium vulnerability: Mexico, Chile, Brazil, Colombia, Czech Republic, Hungary, Poland.
  • Low vulnerability: Korea, China, Thailand, Russia.


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