Emerging Market Turmoil Abating?
This report will examine the causes and mechanics of the recent market contagion regarding EM countries.
WHILE IT IS easy to group Emerging Markets (EMs) into convenient and often catchy acronyms, and by extension into one broad asset class, it might not be wise. Just as in the developed countries of the US, UK, Japan and the European Union, structural issues, politics, and fundamental dynamics amongst all the countries are very distinct and differentiated. This differentiation is even more pronounced among EM countries. Yet, to some extent the securities related to EM sector exposures often do share a relative lack of liquidity when compared to developed countries, giving the generalization some credence, especially during market sell-off episodes where liquidity challenges exacerbate the market impacts and lead to the characterization as contagion. What this also means is that market developments that lead to improved liquidity may assist in deterring future episodes of contagion.
Figure 1: Selected Emerging Market FX vs. US Dollar (30 Apr 2013 – 31 Jan 2014)
Colombian Peso Mexican Peso Malaysian Ringgit Chinese Renminbi
Indonesian Rupiah South African Rand Brazilian Real Chilean Peso Indian Rupee Russian Ruble Thai Baht
Argen/ne Peso Turkish Lira
Source: Bloomberg Professional -‐40% -‐35% -‐30% -‐25% -‐20% -‐15% -‐10%
-‐5% 0% 5% This report examines the causes and mechanics
of the recent market contagion regarding EM countries. Our key conclusion is that relative out- performance by the US equity market in 2013, economic growth deceleration in many EM countries, rising political risks, and the mechanics of asset allocation shifts in these less liquid markets were the four primary causes of the contagion episodes in the spring of 2013 and winter of 2013/14. We are not in the camp arguing that the
66 March 2014 By Bluford Putnam & Samantha Azzarello
tapering of quantitative easing by the US Federal Reserve was a primary cause of the EM currency market sell-offs. To illustrate the differences among EM countries, we will outline the issues facing Brazil, India, and China, as they manage their currencies in the face of contagion fears and in the context of their own economic and political evolution. We also argue that more active trading in non-deliverable forward agreements (NDFs) on EM FX, along with improved economic conditions in the US and some modest growth in Europe after years of stagnation, will help stabilize EM markets in 2014. This more optimistic market scenario based on an economic perspective, however, is dependent on how political risks evolve.
Causes of Recent EM Contagion Market
contagion often affects unsuspecting
parties who have not necessarily done any wrong. In the context of the EM sell-offs in May-June of 2013 and January 2014, we can decompose its probable causes, starting first with a look-back at US markets. Despite former Federal Reserve Chairman Ben
Bernanke’s “Taper Talk” in May 2013 and the official Federal Open Market Committee (FOMC) decision to start tapering asset purchases (QE) in December 2013, the US equity market powered on to new highs. The equity rally occurred even as the US 10-Year Treasury yield went from less than 1.7% at the end of April 2013 to a new range, 2.6% to 3.0%, a full 100 basis points higher than before the “Taper Talk.” The ability of US equities in 2013 to effectively ignore the impending policy change at the Fed to taper QE while US bonds were selling- off aggressively strongly suggests to us that QE was not responsible for EM contagion. The buoyant performance of US equities, which were directly in the line of fire of rising US bond yields, leads us to conclude that one of the primary causes of these two episodes of EM contagion was US equity out- performance rather than tapering of QE. With EM equities lagging badly in 2013, it was only natural for asset allocators to shift away from them. Relative out-performance of US equities, in turn, was rooted not just in the strengthening
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