Emerging-Market Decline Leads to 5 1/2-Year Low on FedYe Xie
It’s back. The rout that gripped emerging-market currencies last year is now sending exchange rates to their weakest levels since 2009.
An index of 20 major developing-nation exchange rates fell today to a 5 1/2-year low. Options betting on a drop in the “fragile five,” or those currencies vulnerable to capital flight such as South Africa’s rand and Turkey’s lira, cost the most in seven months.
As recently as July, developing-nation currencies were enjoying a renaissance, flirting with their highest levels of the year, amid the outlook for stronger economies. Now, that optimism is waning on concern the potential for higher interest rates in the U.S. will curb demand for assets in countries generally considered riskier just as the outlook for growth worldwide dims.
“Foreign exchange is the best antenna for picking up signals, reflecting emerging markets’ troubles and transmitting those to other asset classes,” Bhanu Baweja, the head of emerging-market cross-asset strategy at UBS AG in London, said by phone Sept. 12. “The market is concerned about U.S. rates rising. The fragiles will get hurt.”
U.S. Federal Reserve today maintained a commitment to keep interest rates near zero for a “considerable time” after asset purchases are completed, while raising their rate forecast for 2015. The Organization for Economic Cooperation and Development trimmed its growth forecasts on Sept. 15 for the biggest developed economies in the face of increasing geopolitical risks and subdued European inflation.
Twenty-three out of the 24 emerging-market currencies tracked by Bloomberg have weakened versus the dollar this month, led by a 4.6 percent drop in Brazil’s real. Morgan Stanley coined the term “fragile five” in August 2013 to describe Brazil, South Africa, Turkey, Indonesia and India, which are particularly reliant on foreign investment to fund current-account deficits.
Bloomberg’s currencies index fell to 88.86 at 4:14 p.m. in New York, the lowest since April 2009. The measure suffered its worst start to a year since 2009 in January, prompting banks from Morgan Stanley to UBS to draw parallels with the Asian crisis of the 1990s.
The gauge is down 3.3 percent this year, extending the 7.1 percent drop in 2013, when the Fed said it would taper its $85 billion of monthly bond purchases. With that program due to end next month, investors are turning their attention to rates.
Futures indicate a 78 percent chance of an increase in the target Fed funds rate by the central bank’s September 2015 meeting. Fed officials raised their median estimate for the federal funds rate at the end of 2015 to 1.375 percent, compared with 1.125 percent in June.
Five-year developing-nation bonds yield an average of 4.88 percentage points more than similar maturity U.S. Treasuries, near the least since June 2013, data compiled by Bloomberg show.
A signal for higher borrowing costs would “definitely hurt” emerging-market currencies “because of the lower rate differential, which is a key factor” for investors, Roland Gabert of DWS Investment GmbH, which manages $1.3 trillion from Frankfurt, said by e-mail on Sept. 15.
JPMorgan Asset Management, which manages $1.7 trillion, sees the declines as an opportunity to buy certain developing-nation currencies, even as an increase in volatility from a record two months ago makes them riskier.
“There’s no reason why the Fed should spook the market,” Pierre-Yves Bareau, JPMorgan Assets’ head of emerging-market debt, said by phone on Sept. 15. “We’re clearly cautious, but if we see further weakness, we’d consider some currencies a buy.”
Morgan Stanley isn’t as optimistic, predicting “a day of reckoning” for developing currencies, economists Manoj Pradhan and Patryk Drozdzik wrote in a report on Sept. 15. While India has improved its current-account position, Brazil, South Africa and Turkey haven’t done enough and remain at risk, they wrote.
Brazil fell into recession in the first half of the year, while Russia is struggling with U.S. and European Union sanctions for its involvement in the Ukraine conflict. Official data yesterday showed that foreign-direct investment to China, which buys everything from Brazil’s iron ore to South Africa’s copper, unexpectedly declined in August from a year earlier.
China is injecting 500 billion yuan ($81 billion) into the nation’s largest banks, according to a government official familiar with the matter.
The People’s Bank of China will funnel 100 billion yuan each to the five biggest banks for a three-month period, said the official, who asked not to be identified because the measure hasn’t been formally announced.
U.S.-based investors have pulled $4.7 million from exchange-traded funds specializing in emerging-market currencies over the past month, extending outflows this year to $81 million, or 45 percent of assets, data compiled by Bloomberg show. The rout is yet to contaminate bonds and stocks, with those funds seeing inflows of $1.9 billion since Aug. 16.
The premium on one-month options giving the right to sell the fragile five currencies over contracts allowing for a purchase widened to an average 2.1 percentage points yesterday, data compiled by Bloomberg show. That’s the most since February and up from a low for the year of 1.16 in May.
“Emerging markets have deteriorated,” Stephen Jen, the managing partner at SLJ Macro Partners LLP and a former International Monetary Fund economist, said by phone from London on Sept. 11. “The Fed is diverging from the rest of the world. Emerging markets will likely weaken further.”