Recent falls in major emerging market currencies has exposed weak links in the broader EM world. Investors are reducing exposure to the ‘fragile five’ countries of Turkey, Argentina, South Africa, Indonesia and India given their dependence on external funding thereby putting pressure on their currencies and other EM currencies.
As we have seen, the Argentine peso has dropped to new record lows since it announced it would require an IMF bailout sooner and then proceeded to push interest rates to an eye-watering 60%. The peso is down 52% year-to-date. Turkey’s lira continues to weaken on the state of the economy and its central bank avoiding interest rate rises given it has only being able to put through borrowing limits on overnight banking transactions. The lira is down 42% year-to-date.
Also in the spotlight is India as its macro stability will be impacted by oil prices and the rupee. South Africa has entered recession and Indonesia’s rupiah is hitting record low not seen since the Asian financial crisis as the country’s foreign liabilities has made it one of the most exposed in Asia.
What we are witnessing currently is a confidence crisis in emerging markets with a small level of contagion flowing into developed-market currencies. These short-term movements make it difficult to jump in. The falls in the Turkish lira and Argentine peso are largely idiosyncratic shocks but the impact of rising U.S. interest rates and a strong dollar are having an impact on vulnerable emerging market economies with overseas funding shortfalls which is having a spill over effect onto other EM currencies such as the rand, rupiah and Indian rupee. This displays the risks of chasing yield in a risky emerging market currency environment.
With a relatively young, growing population, an expanding middle class and increasing wealth, we see the outlook for consumer spending in Asia to remain buoyant. There are stocks that look currently attractive in Hong Kong, Taiwan, South Korea and India. However, with President Trump imposing tariffs on an additional $200 billion of imports from China and the expectation of further equivalent retaliation damaging both economies, this may adversely impact global supply chains for which Asia plays a key role. As a result, income growth could slow dampening consumer confidence leading to reduced consumer spending.
Although Asian equities were significantly outperforming EM stocks more broadly until mid-June, the region represents 75% of the MSCI Emerging Markets Index with China, Taiwan, South Korea and India accounting for 65% weighting of the index. Irrespective of current economic fundamentals of particular countries, EM currencies and equities have been trading and moving as a bloc during the past few weeks. The Index is down 19.8% since its January peak.
Despite the lack of wider contagion into developed markets, pressure on emerging markets will probably persist for now. We are currently experiencing a once-in-a-decade slump; the longest since 2008. A long selloff is a good argument for buying the dip. EM equity valuation are now the lowest among global markets and ideal time to rebalance portfolios.
Overall, we don’t see this as the time for investors to take large risk taking positions within EM given what has happened to currencies belonging to countries without direct economic links. Negative sentiment largely remains amid uncertainty in Argentina and Turkey despite both economies not being major parts of the global EM economy. Higher U.S interest rates and a stronger dollar are contributing to continuing capital outflows. Furthermore, China’s economy is slowing with the manufacturing PMI dropping for the third consecutive months and fixed-asset investment growth slowing to its weakest speed in 18 years. All this should serve as a reminder on the risk of holding EM assets and on that basis, we continue to keep a neutral position for EM high-yielding currencies and equities.