With January drawing to a close, one can only conclude that it was dominated by risk-off trading activity. In the last trading week of the month, investors continued to sell equities and moved money into assets they perceived to be safer, such as US or German government bonds, and commodities, such as gold. Hardest hit were emerging market stocks, which the FT reported saw a money drain of more than $12bn in January 2014. However, today all stock markets suffered, with both the S&P 500 and the EuroStoxx 50 down almost one percent.
Hot money flows not only sent EM stocks dwindling down but especially caused heavy losses in the respective countries' currencies. Since many emerging market economies already suffer from current account deficits or political complications and rely heavily on imports, the depreciation of their local currencies seen in 2014 so far represents a serious risk for their further economic growth and recovery.
In Turkey, the main risk remains the country's prime minister, Recep Tayyip Erdogan, who at first opposed a rate hike deemed necessary by most economists and who desperately fights for being able to keep his political power, apparently believing that the country is being undermined by foreign conspirators. As became evident over the past few months, Turkey suffers from a high level of corruption. Just this week the government removed another 800 police officials and many prosecutors from their positions. The Turkish lira is all the more vulnerable because the country's foreign reserves are draining off. If the recent increase of the deposit rate does not keep hedge funds from betting against the TRY, the central bank will only have very limited resources available to support the currency. Earlier this week, Mr Erdogan told journalists that he had additional fire power ready to support the TRY, but he did not give any details or supporting facts, which will hardly convince professional investors that the government will be prepared to fend off TRY shorts.
Inflation also poses a challenge for South Africa, whose currency has already fallen some 6% against the US dollar. The country's unemployment rate is a whopping 25% and there continue to be crippling mining strikes. South Africa is slightly better off in terms of foreign reserves than Turkey, though. It also recently raised interest rates to stop the decline of the ZAR. From a technical point of view, we believe that USDZAR short may be a nice short-term trade idea. As of now, the ZAR trades below 11.14 and just today managed to stay well away from its low around 11.38. With ZAR short positions already at very high levels, technical oscillators such as the RSI indicating that the currency is temporarily oversold and EM central banks finally waking up, we see a chance that the ZAR will recover against the USD over the next few weeks but recommend setting SL limits not too far away.
Thursday saw the Turkish lira (TRY) decline further despite the Turkish central bank's surprise move from Tuesday night to more than double the weekly repo rate to 10 percent (although effectively this was more like a 7 to 10% hike considering that the CB had previously not lent money at the official rate of 4.5%). The decision was all the more bold given Recep Tayyip Erdogan's clear opposition to higher interest rates.
At first, the TRY quickly rebounded from its all-time low against the USD of more than TL2.39 to roughly TL2.16. However, that has only been a temporary breather with hedge funds well aware of Turkey's economic and political challenges as well as the central bank running out of foreign currency reserves. On Thursday, the situation turned worse again following both strong economic data releases from the US and disappointing news from Turkey where it has been reported that the government again removed more than 800 police officials and 90 prosecutors from their positions. The political struggle is far from over, causing further USDTRY volatility.
Other EM currencies faced similar challenges. For instance, the decision in South Africa to carefully raise rates on Wednesday, although a surprise, was not as bold as the rate increase in Turkey and was very short-lived, too. The Rand is among the biggest EM currency losers and currently trades at ZAR 11.21 per USD. Emerging market woes were additionally fuelled by the Federal Reserve's clear stance to continue to reduce its monthly asset purchases. In Ben Bernanke's last speech as Fed chairman, he did not mention the emerging markets with one word, hinting at the US just not caring about the problems of the weaker countries.
The past week of trading was all about emerging market (EM) currencies. Following the US Federal Reserve's announcement in May that it would soon begin tapering its bond purchases and thereby exit the phase of extremely low US yields, EM currencies have come under pressure as investors started to move capital back into US securities. That capital had originally been invested outside the US in search of higher returns. Now that yields in developed countries are expected to slowly increase again, many investors have begun to repatriate their holdings. This development accelerated this calendar week after the release of the latest FOMC minutes, which included further hints at Fed tapering.
Several countries' currencies were hit particularly hard: The Indian rupee (INR) fell to record-low levels. It currently trades just below Rs65 to the US dollar (USD), significantly above levels of Rs55 from the beginning of the year. The depreciation of the INR gained momentum when the Reserve Bank of India (RBI) introduced capital controls on August 14th to prevent local investors from moving money out of the country -- a decision that worried foreign investors, who in turn exchanged more of their INR holdings into USD and other developed countries' currencies. The Indian finance minister, Palaniappan Chidambaram, has since ruled out further capital controls in an attempt to calm the markets and remove volatility.
The Brazilian real (BRL) also continued to depreciate in the past week and now trades at around BRL 2.40 per USD. Brazil's currency is now close to the high values of roughly BRL 2.57 it reached in late 2008. Alexandre Tombini, Brazil's central banker, acted more decidedly to stop the BRL's depreciation than his colleagues from other EM countries. First of all, he decided not to attend the annual conference of central bankers in Jackson Hole to be able to monitor his country's currency. In addtion, Mr Tombini announced a $60bn intervention programme, which includes one auction of currency swaps per day and the sale of repurchase agreements every Friday until the end of 2013. The programme sends a strong signal to investors that Brazil is not going to run out of US dollar reserves and will be able to intervene to stop its currency from falling. In a first success, the real gained back some of its losses by falling from its high of BRL 2.45 to the Friday "close" of BRL ~2.40. However, taking the big hedge funds' and investment banks' capitalizations into account, the intervention programme still looks small in size and it is questionable whether Mr Tombini's promise is actually believable over a horizon of more than a few days or weeks. While he may have won this one battle, the war is certainly not over so-to-speak.
Indonesia also intervened, albeit less ambitiously, by announcing the increase of import taxes on luxury cars and tax incentives for companies investing in agriculture. This move was aimed at reducing the oil imports, but it is unlikely to stop the devaluation of the rupiah (IDR), which was particularly sharp. As of this writing, the IDR trades at 10,775 per USD, more than 10% above its level from January. Other EM currencies, such as the Turkish lira (TRY) and the South African rand (ZAR) have also been under increased pressure. Emerging market countries can expect to struggle during the remainder of this year and most likely also in 2014 not just due to the United States exiting its monetary easing programmes, but also because of internal issues, such as high inflation rates, slowing growth rates and large account deficits.