G20 wades in on emerging-market rout
Hopes are growing that concerted Brics policy action – with the creation of a $100 billion swap fund – and bargain-hunting will help engineer a rebound in sentiment towards EM currencies.
The Brics economies’ bid to create a $100 billion swap fund helps, at the margin, to boost sentiment in emerging market (EM) currencies while greater credit differentiation and more attractive valuations should pave the way for a rebound, say analysts.
Brazil, Russia, India, China and South Africa agreed last week to pay into a $100 billion swap fund to support EM currencies amid a prolonged sell-off in asset markets after Federal Reserve chairman Ben Bernanke signalled his intention to start tapering off quantitative easing (QE), though this fund is not expected to become operational for some time.
Russian president Vladimir Putin announced the initiative at the G20 meeting in St Petersburg amid increasing signs that central banks are taking coordinated steps to support currency markets, though this $100 billion firepower is modest compared with the estimated daily FX trading at about $5 trillion.
China, owner of the world’s largest foreign reserves, committed $41 billion to the fund, with Brazil, India and Russia each committing $18 billion. South Africa contributed $5 billion, according to a Reuters report.
Currencies such as the Brazilian real, Indian rupee, Indonesian rupiah and Turkish lira have dropped precipitously over the summer. For example, the WisdomTree Emerging Markets Currency ETF, which holds non-deliverable forward positions in 15 currencies, is down 7% year-to-date as money began to flow out of local currencies in expectation of higher dollar returns.
“The market really has spent the entire summer transfixed by QE and tapering and the consequences for emerging markets, especially countries that have a marked need for foreign direct investment,” says Paul Chappell, founder and chief investment officer at C-View, a UK-based currency manager.
“These fears have caused substantive deterioration in some currencies and investors have made significant divestments from local funds as a result.”
He adds: “Taken in the context of historically large reserves held by developing economies, multilateral initiatives like the recent joint swap fund are welcome evidence that central banks are now much better prepared to deal with currency volatility and defend their currencies than they were in the late 90s.”
Funds that hold bonds denominated in local currencies, which have grown popular in recent years as investors have sought increased market exposure, have taken a particularly bad battering in the past few months.
For example, Aberdeen Global’s Emerging Markets Local Currency Bond Fund is down 10.63% during the past three months, and has lost 13.87% since the beginning of the year. Pimco’s Emerging Local Bond Fund, meanwhile, fared slightly better, but is still down 13.59%.
The exodus out of EMs has been gathering steam this summer, according to Boston-based fund data provider EPFR Global. EM funds have endured net outflows for the past three-and-a-half months, with combined redemptions of $5.6 billion last week. Stock market outflows last week overtook bonds, while the fixed-income sector has been losing capital for 15 straight weeks, states EPFR.
“India, Indonesia, Turkey, South Africa and Malaysia have suffered the most pain in their bonds, equities and currencies.
“Tapering started the problem, but bad economics took over and investors are now exiting currencies with relatively large trade deficits and fiscal problems,” says Robert Savage, chief strategist at FX Concepts, New York-based hedge fund. “Some of these countries have the semblance of stagflation, where nominal GDP might increase but real GDP doesn’t.”
However, weaker-than-expected non-farm payrolls data at the start of the month saw currencies with relatively better economic outlooks recover some of their losses, suggesting the summer selling action is probably overdone. For example, the Indian rupee is now back below 65 to the US dollar, after falling to 69, equivalent to around a 7% recovery.
“This sort of abject sell-off is not atypical of the summer and it feels like it’s overdone,” says Chappell. “In the last few days we have seen some recovery in currencies from economies with more robust economic fundamentals, for example Mexican peso, Philippine peso and Thai baht.”
Notwithstanding recent fund outflows, some local currency fund managers suspect markets are pricing in too much tapering too soon and say that markets typically over do these things.
“Over the past 10 years, quarters in which total returns were negative were followed by quarters of positive returns more than 70% of the time in local currency – and US dollar-denominated EM bonds,” says Ramin Toloui, global co-head of EMs portfolio management at Pimco in Singapore.
“This implies that, in the past, a certain amount of mean reversion has been the norm, in which selling during periods of stress overshoots and is followed by a bounce in prices after the stress subsides.”
The single biggest factor in support of EM central banks is their large FX stockpile, compared with the Asian and Latin American crises.
For example, Brazil now holds $369 billion of reserves, compared with $193 billion in 2008. Korea’s reserves have grown to $323 billion from $201 billion in 2008. China holds the world’s largest foreign reserves equivalent to $3.3 trillion.