The current selloff in emerging markets (EM), which has rattled markets including Argentina, Brazil and Turkey, saw USD$12.3 billion of foreign money leave emerging markets during May. While there is no single reason, we point to a combination of factors including a stronger U.S. dollar and higher U.S. debt costs. Countries with some combination of high external financing requirements, high U.S. dollar-denominated debt and large foreign investor portfolios will be most affected. As a result, this has generated much volatility in EM currencies and prompted HXL to review our EM strategies.
Overall, despite higher U.S. interest rates, a higher U.S. dollar and higher oil prices, the economic fundamentals in developing countries remain mostly intact with the exception of Argentina and Turkey. Emerging markets are up 4% of their lows in May. Some of the countries that were in focus two-to-three weeks ago like India and Indonesia have seen their currencies increase due to the U.S. dollar weakening on the increasingly likelihood that the European Central Bank (ECB) will stop quantitative easing policy. With a falling U.S. dollar, investors are putting funds into EM markets. Therefore, we see this talk of an emerging crisis in EM as overblown and some stories should be avoided.
The recent selloff in emerging market currencies and changes to monetary policy has resulted in buying opportunities in some of them. This year, central banks in Turkey, Indonesia, Malaysia, Philippines and recently India have raised interest rates to fight inflation and stabilise their currency as the U.S. tightens monetary policy. This has slowed capital outflows as investors search for higher yields and as a result, we are buying the Indonesian rupiah, Philippines peso, Indian rupee, Thai baht, Korean won, Mexican peso and the Chilean peso.
We expect one more interest rate rise in India in the next few months, most likely in August, if oil prices remain high. Otherwise, we expect a further 50 basis point increase in FY2019 supporting our view to purchase the rupee.
The Philippines currently has the fastest inflation amongst the six biggest Southeast Asian economies as it relies almost entirely on fuel imports. As oil prices increase, bus, taxi, airlines and other transport operators are asking to raise prices to cover costs resulting in labour groups demanding higher wages thereby fuelling inflationary pressures. This will force the central bank to increase rates again and supports our view to purchase the peso.
Thailand has not increased rates since 2011 as inflation is low. However, rising diesel and cooking gas prices is feeding domestic inflationary pressure which surged to its highest level in 14 months. As energy prices remain high and to prevent the Baht from weakening further, we expect the Bank of Thailand to raise rates by the end of this year, supporting our view to purchase the baht.
Despite the Malaysian ringgit presenting itself as a buying opportunity, the currency has been heavily sold-off due to lingering concerns connected to a change in government for the first time in six decades. We are waiting to see what will happen in Malaysia and not buying the ringgit for the moment as investor confidence is largely absent as markets deal with the impact on the budget after Prime Minister Mahathir Mohamad scrapped the 6% Goods and Services Tax (GST), putting pressure on government revenues. In addition, the economic outlook looks unclear as the Prime Minister reviews large-scale investment projects. Adding to the economic uncertainly is the sudden resignation of the central bank governor, the latest in a string of departures as the Prime Minister purges top officials seen as close to the previous government.
While we have picked some bargain Malaysian stocks and taken up some buying positions in the ringgit, until some clarity in both political and economic policies emerges, we will continue to sell the ringgit in the short-term but take advantage of any oversold positions. Please refer to our Malaysian Economic Update for a separate analysis.
There is no doubt that the economic fundamentals in Brazil have deteriorated badly with slowing economic growth and political uncertainty ahead of general elections in October. Furthermore, the recent trucker’s strike that crippled its economy has highlighted that it will be difficult for any government to implement tough fiscal reforms that is required to reduce government debt and restore economic growth. Building on our recent gains, we continue to see difficulties going forward and continue to sell the Brazilian real. However, we still maintain an overall ‘neutral’ rating as the global economy continues to grow feeding into stronger commodity prices which should benefit the Brazilian economy.
Have EM fundamentals been badly damaged by this period of weakness? Our argument is, leaving aside economic problems in Argentina, Turkey, our recent economic downgrade of the South African economy due to poor Q1 GDP data, and economic downgrades in Brazil and to some extent Indonesia, we continue to buy EM equities as earnings growth is holding-up and we forecast EM earnings to grow by 15% this year. Therefore, it is very hard to state that EM fundamentals have deteriorated which means if the U.S. dollar continues to fall (as we forecast), EM assets will continue to rally. However, if a stronger dollar returns, this would create a much more challenging environment.