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Last updated: October 1, 2013 7:12 pm
The euphoria did not last long. When the US Federal Reserve decided last month to delay a withdrawal of its stimulus, many analysts predicted the reprieve would lift emerging markets until the end of the year. But the initial rally has already fizzled.
In fact, emerging market borrowing costs are now marginally higher than they were the day after the Fed announcement, and the FTSE Emerging Markets gauge of blue-chip stocks is down just under 1 per cent over that period.
Foreign exchange markets seem especially indifferent to the Fed’s unexpectedly dovish stance. Except for the Romanian leu, all emerging market currencies have slipped below the levels they reached against the dollar on September 19, in the immediate aftermath of the Fed’s decision. Some, including the Turkish lira, South African rand and Indonesian rupiah are not far from the lows of the previous month.
The brevity of the rally has wrongfooted many strategists, many of whom switched their stance from bearish to “tactically bullish” for the rest of the year after the Fed announcement. Now they are nonplussed.
“I really have been scratching my head,” Benoit Anne, head of EM strategy at Société Générale, said in a note. “In fact I can’t remember the last time I observed such a large unexplained correction.”
Big swings in risk appetite triggered by the tapering delay, the uncertainties over succession at the Fed and – more recently – the prospect of a US government shutdown and looming debt ceiling talks may partly account for investors’ caution.
HSBC analysis of correlations between currency pairs shows that the pattern of risk-on, risk-off trading that prevailed until mid-2012 returned to emerging markets currencies – although not to developed markets – this summer and intensified in September.
Some asset managers are still optimistic on EM currencies. Patrick Zweifel, chief economist at Pictet Asset Management, reckons they are now as undervalued as they were during the global financial crisis, and will recover as developing economies regain their verve later this year.
Emerging markets are taking a battering as investors withdraw at the prospect of higher global interest rates
“We know we’re near an inflection point for global monetary policy. This has often been a trigger for emerging markets to underperform … But emerging markets are much less vulnerable than they were,” he argues.
The reversal, though, reflects the degree to which investors remain focused on the fundamental problems affecting many developing countries, which were previously able to defer reforms thanks to the flood of dollar liquidity created by the Fed’s emergency asset-buying programme.
“At the end of the day, they are going to taper and this will give a lot of volatility ... This year is payback for the last few years,” says James Kwok, head of currency management at Amundi, the French asset manager.
Now, even though the US shutdown makes it less likely that the Fed will start to scale back stimulus soon, many investors appear unwilling to bet on a rebound.
“Unless accompanied by meaningful, growth-enhancing reforms, any rebound in risk sentiment towards EM would likely be shortlived,” predict analysts at Morgan Stanley, who this week cut their stance on EM currencies to “hold”.
The US investment bank’s strategists argue that slowing growth and worsening current accounts need to be reflected in wider credit spreads and weaker currencies – and that “easy money policies from the Fed do little to change this”.
Still, many analysts and investors say discrimination is in order. Some countries and currencies with economic weaknesses will continue to struggle, while others will regain their footing.
This focus on macroeconomic fundamentals explains a recent divergence among currencies that had risen and fallen together in line with global risk appetite for much of the past few years. HSBC’s analysis shows a much higher correlation in the 10 worst performing currencies than for EM as a whole.
For example, Asian currencies have in general outperformed – with Citi’s currency traders observing heavy buying by hedge funds and institutional investors.
“You want to be overweight in the emerging markets that are more ‘developed’ – those that are in a structurally better position and more leveraged to developed market growth,” says Roger Hallam, currency chief investment officer for JPMorgan Asset Management.
Analysts at Credit Suisse say investors are bullish on the Mexican peso, South Korean won and Polish zloty. Most were also betting that recent action by India’s central bank would support at least a partial recovery in the rupee. But they were disinclined to make big bets on other EM currencies and were universally bearish on the Turkish lira.
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