FX Emerging Markets WHAT happened?
EM assets – currencies, bonds and credit – have all come under significant
selling pressure since
mid-May. Earlier on the softening in EM activity and lower inflation pressures in April encouraged EM central banks to resort to monetary stimulus once again, pushing front-end rates lower. In addition,
bonds and currencies
rallied in anticipation of capital inflows following the BoJ easing. So by early May yields had declined to well below the level that the typical relationship with G3 yields would imply and EM currencies had rallied despite narrowing interest rate differentials. All of a sudden a quick sharp rise in US yields caught EM assets by surprise. Even more so, since the move was steeper as far as real yields were concerned, inflation expectation has been coming off at the same time. As local currency rates premiums (local currency versus
Dollar-denominated
sovereign yield spreads) compressed on the back of higher US rates, currencies weakened rapidly. Moreover, the starting point – one of EM FX relative strength, recently exacerbated by the mentioned BoJ- induced euphoria – implied that there was some catching-up to do. EM currency weakness
quickly
translated into a broader EM asset sell-off (including bonds and credit) and the moves across EM assets have been quite large. Amid such violent price action it is easy for excessive concerns over rapid capital outflows
10 FX TRADER MAGAZINE July - September 2013
and exponential price action to prevail. Of course, as it usually happens at times of excess volatility and positioning unwinds, weakness in EM assets may well become idiosyncratic. And there is room for EM assets to sell off further. Tings are not made easier from the fact that this sell-off is hitting on generally fragile and fearsome markets, already being put to the test from horrific price action in gold a few weeks ago and in the Nikkei pretty much at the same time. Generally risk aversion has been woken up by rising interest rates markets volatility.
Trying to put events a bit more in a cause-effect logic we could identify three concomitant reasons behind the current debacle:
• ‘Taper talk’ from the Fed (i.e. 2013 GDP growth forecast (%)
-2 -1 0 1 2 3 4 5 6 7 8 9
China India Brazil Russia Chart 1: 2013 GDP Growth forecast (%) March June
Federal Reserve recognition that US economy is alive and resilient despite all “Fiscal Cliff” worries)
• Disappointing EM growth, especially in the biggest (BRICs) economies
• Crowded positions in this asset class after years of ‘search for yield’ in global portfolios
EM growth disappoints
The fact that EM growth has turned a lot less appealing at this juncture has certainly contributed to the ongoing deleveraging. In fact market sentiment towards emerging markets is also being negatively affected by lingering concerns about the outlook for the biggest emerging economies.
US Japan Europe Source: Deutsche Bank
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