August ended with another round of turmoil across emerging markets and it isn’t clear that the flip of the calendar will bring much relief.
“It is hard to tell how much of this is month-end and real money stopping out of long held favorites like India, Argentina, Brazil, etc. Or how much of this is actually something more than that,” said Brad Bechtel, an analyst at Jefferies, in a Friday note. “Coming weeks will tell us a lot about that but I get the general sense that we are not out of the woods just yet.”
Argentina’s central bank delivered an emergency rate increase Thursday, lifting its rate from 45% to 60% and vowing not to cut until at least December. The move did little to halt a two-day plunge that took the peso
to an all-time low. A bounce on Friday still left the currency down more than 16% for the week and nearly 50% in the year to date.
also dropped sharply Thursday after the resignation of the country’s deputy central-bank governor.
While Turkey and Argentina suffer a variety of unique, homegrown problems, the countries carry large current account deficits, economists noted, a measure of a nation’s balance of trade, net earnings on foreign investments and net cash transfers.
Countries with large current account deficits have suffered the most, economists have noted (see chart above). They’re left vulnerable due to large dollar debts, which become more difficult to service as their domestic currencies weaken against the greenback. Economies like India, Colombia and South Africa with similar debt profiles and current account deficits have also come under the spotlight.
But experts also argue that while Turkey and Argentina face a serious crunch, the other countries aren’t in a position that signals a threat on par with the Asian financial crisis of 1997-1998.
“India and Brazil have substantial reserves, and thus there is no real risk that a weaker currency will cause them trouble in repaying their external debt,” wrote Brad Setser, a senior fellow at the Council on Foreign Relations, in a Thursday blog post. “South Africa and Indonesia don’t have access to comparable reserve stockpiles, but they are doing the right thing by letting their currencies adjust.”
Setser said that leaves Turkey and Argentina to stand out as the two emerging economies with the most obvious vulnerabilities, sporting the largest current-account deficits going into 2018 and insufficient reserves relative to debt.
Investors fear ructions in emerging markets will have the potential to spill over to other countries in other ways.
For example, Turkey’s euro-denominated borrowings means it’s collapse could portend trouble for EU members with financial linkages to Ankara. European banks like Spanish BBVA are on the hook via Turkish subsidiaries. If they’re forced to write off their loans to Turkish firms, then their capital buffers could take a sharp hit, according to analysts from TS Lombard.
But Turkey’s small weighting in emerging market indexes suggest the swoon in its financial markets won’t deliver much of a direct hit to investors’ portfolios. Turkey’s gross domestic product stood at around $850 billion in 2016. It’s stock market, however, amounted to less than one percent of the MSCI Emerging Markets Index. The index-tracking iShares MSCI Emerging Markets exchange-traded fund ended the week down 0.5%. Wall Street paid little heed, with the S&P 500
posting a 0.9% weekly rise to cap a 3% August rally.
“Turkey is too small to spark global contagion,” wrote Michael Arone, chief investment strategist for State Street Global Advisors, in a note.
Perhaps more troubling, said analysts, is recent reports that President Donald Trump will go forward with $200 billion worth of tariffs on Chinese imports next week.
That could provide the missing link between emerging-market weakness and U.S. markets, which have been inured to trade tensions, so far. As the second largest economy, China is a linchpin of international trade. A slowdown in China could therefore weigh on neighboring economies and result in a knock-on slump in global growth.
Bechtel argued that the “complete ambivalence” of U.S. markets, both equity and fixed income, to the emerging-markets tensions is unusual but also makes “perfect sense.”
“As the rest of the world continues to deal with U.S. Fed policy changing, U.S. asset markets become more and more attractive,” he wrote. “This is not a dynamic that is likely to end soon either and I still see scope for further gains in U.S. rates, equities and the U.S. dollar.”
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