Rout-sizing: How will investment banks cope with the emerging market sell-off?
The roller coaster in emerging markets threatens one of the few consistent bright spots for investment banks since the global financial crisis. If the rout spreads, they could be faced with a sharp decline in FICC trading and a collapse in deal flow. But bankers remain remarkably sanguine. Could this be the sell-off that finally proves the EM asset class has come of age?
There is a phrase for it: the soft bigotry of low expectations – the markets’ impulse to dump emerging market assets at the first sign of a crisis.
In the first six weeks of the year, emerging markets felt the full force of traders’ low expectations as the market dramatized the sell-off in equities, FX and rates markets in nations with high current-account deficits. Fears of full-blown and synchronized trouble akin to the Asia crisis of 1997-98 snowballed.
It looked like a return to the dark days of the emerging markets as central banks from Turkey to India were forced to engage in aggressive rate increases, and fears grew over foreign-currency reserve losses exacerbated by policy blunders in Argentina, Turkey, Thailand and Venezuela.
Emerging market assets tend to overshoot on the downside, given their high-beta status, structural illiquidity and the tendency of crossover investors to flee en masse, thereby triggering broader macro fears. Nevertheless, much of the market commentary shifted to hyperbole. The sell-off – inaccurately described as a ‘slump’, ‘carnage’, or ‘indiscriminate’ – had Argentina, which constitutes less than 2% of the MSCI emerging market index, gracing the front pages of western newspapers.