Rand leads sell-off with no relief in sight for emerging markets

The rout in emerging markets showed no sign of letting up, with most currencies weakening and an index of stocks heading toward a bear market.

South African bonds led the sell-off in fixed income as the rand weakened to its lowest level in more than two years. The MSCI Emerging Markets Index of shares dropped for a sixth day, set for its steepest slide in three weeks. Worst-hit was Indonesia, where shares tumbled the most in three years amid concern the depreciating rupiah will lead to higher corporate borrowing costs.

The declines added to concern investor nervousness is beginning to infect markets whose economies are more robust than others. The negative tone was set on Tuesday by a US manufacturing report that boosted the odds of further Federal Reserve rate increases and a strengthening dollar, and South African data showing the economy entered into a recession in the second quarter.

“This has become now increasingly an issue which is no longer just about EM fundamentals,” Sameer Goel, head of macro strategy for Asia at Deutsche Bank in Singapore, said in a Bloomberg TV interview with David Ingles. It’s “increasingly about contagion, which largely happens because of cross-holdings and the pressure of redemptions”.

Indonesian equities sank for a fifth day as policy makers attempted to support the rupiah through measures including interest-rate hikes that threaten to slow Southeast Asia’s biggest economy. Shares in the Philippines extended losses after a report showed inflation - spurred in part by currency weakening - surged past 6% last month, foreshadowing further potential rate rises there.

“Investors have become more selective, and countries with negative news such as weak economic growth, weak external balances and high inflation face stronger sell-offs, ”said Koji Fukaya, chief executive officer at FPG Securities in Tokyo.

Outside the Asia region, worries remain that Turkey’s central bank may not do enough at its policy meeting next week to shore up the weakening lira. Argentina’s economic outlook has deteriorated even as its officials negotiate with the IMF for accelerated aid. And Russia’s central bank Governor Elvira Nabiullina has begun talking of reasons to raise rates at a meeting next week.

MSCI’s index of developing-nation currencies slipped, heading for the lowest close since April last year. The dollar is climbing toward its highest level in over a year after a gauge of American manufacturing jumped to a 14-year high on Tuesday.

As US rates rise, investor fears over idiosyncratic risks in emerging markets have climbed, from Argentina’s fiscal woes and Turkey’s twin deficits to Brazil’s contentious elections and a land-reform bill in South Africa.

US President Donald Trump’s threats to ramp up a trade spat with China with an announcement of tariffs on as much as $200bn in additional Chinese products as soon as Thursday also hasn’t helped.

Fixed income has also been hit, with the Bloomberg Barclays emerging-market index for dollar bonds down almost 4% so far this year. That leaves it heading for its first negative annual performance since 2013, the year of the taper tantrum. A similar gauge of local-currency debt has fallen almost 8% in 2018.

One silver lining for now is that China, has taken steps to shore up its own currency, including through the re-introduction of a counter-cyclical factor in the yuan’s daily fixing. Policy makers in the biggest emerging market have also taken steps to sustain rapid growth, helping hold up global demand more broadly.

Here’s some further commentary from analysts on the outlook for emerging markets:

Meenal Patel, EMEA head of FX, commodities & rates at JPMorgan Private Bank in London:

"We’re not yet ready to enter into these markets. The market is very much focused on those currencies with large amounts of external debt." The rally in the dollar is making it “very difficult”; Fed policy needs to stabilise . “If we start to see global growth stabilising, start to see other central banks normalise policy as well, that can relieve some of the dollar rally and help EM a little bit as well.”

James Lord, an emerging-market strategist at Morgan Stanley in London:

Morgan Stanley stays short on the currencies of Brazil, Mexico, South Africa, Russia, Indonesia, India and Philippines against the dollar, euro and yen. September is unlikely to provide much relief to emerging markets, Lord and his colleagues at the bank wrote in a note. Trade tensions may remain a theme, and worries about Brazil’s election campaign will probably intensify. Investors may also focus on the outflows of so-called real money, sanctions on Russia and South African land reform over coming months.

Kay Van-Petersen, global macro strategist at Saxo Capital Markets:

“It has to get a lot worse before it gets better” Van-Petersen said on Bloomberg Television. “When you get full contagion, everything gets thrown out, and we’re not there yet.” The key catalyst could be Turkey, he said. The market has underpriced expectations for the Fed, and with Trump waging trade wars on multiple fronts, the tariffs end up hurting emerging markets more than they hurt the US.

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