Don’t panic: emerging market volatility is not a sign of another 2013 ‘taper tantrum’

Tai Hui says Argentina’s interest rate hikes and steep losses for some currencies may lead investors to fear a repeat of 2013 is under way, but abandoning emerging markets would be an overreaction

PUBLISHED : Friday, 11 May, 2018, 10:23am
UPDATED : Friday, 11 May, 2018, 10:34pm

Is the dreaded emerging markets “taper tantrum” scenario playing out all over again? The short answer is no, notwithstanding some scary headlines recently. In an extreme example, the Argentine  central bank was forced to raise its key interest rate from 27.25 per cent to 40 per cent to stop currency depreciation. Such drastic actions are commonly associated with financial crises.  

The Turkish lira and Russian rouble also both slid considerably, down 8 per cent and 10 per cent respectively in the first four months of 2018. Closer to home, the Indian rupee and Indonesian rupiah came under pressure, as well. Some have even compared these corrections to the 2013 emerging market turmoil (or taper tantrum), when the mere mention of a slowdown in asset purchases by the US Federal Reserve sent spasms through the global financial system, causing bond yields to soar. 

When you are on a plane that’s shaking violently, it is important to understand the reason in order to react in the correct way. Scrambling to put on a life jacket when the plane is just hitting a patch of turbulence is overreacting. On the other hand, relying on just the seat belt when you see fire coming out of car engine would be imprudent. So, it is important to understand the backdrop of this episode of emerging market volatility to make a rational investment decision. 

Every market is buffeted by global forces and subject to domestic influences. When it comes to global forces, a stronger US dollar is the culprit. After 18 months of weakening, the US dollar is rebounding, prompted by rising US interest rates attracting more capital into US dollar assets. The emerging market currency index fell 6 per cent between mid-January and early May. This hurts both developed market currencies, such as the euro, Japanese yen and British pound, as well as emerging markets.  

In particular, economies that are dependent on foreign capital to fund their current account deficits, such as Turkey, South Africa, Indonesia, Brazil and India, are traditionally more vulnerable. (These five countries had the misfortune to be known as the “fragile five” during the 2013 taper tantrum.) 

Currency market’s bet against the US dollar is getting riskier by the day 

In addition to global factors, domestic influences are important to differentiate the performances in the various emerging markets. Political uncertainty in Turkey from a snap election scheduled on June 24 has heightened investors’ concerns on its economic outlook. Sanctions against Russia have also prompted a sharp sell-off in the domestic stock market. Argentina’s high inflation, running at around 25 per cent by official calculations, is rekindling worries of contagion and fears that the country will be unable to service its debts. In contrast, in many Asian markets, such as South KoreaChina and Thailand, currency depreciation has been less obvious due to benign inflation and strong current account positions. 

Investors should not lose faith in emerging markets, and use an active approach to look for returns and manage risks. After all, the International Monetary Fund forecasts emerging market growth in 2018 to be at its strongest in five years, and to accelerate further in 2019. 

Forget the Hong Kong dollar, it’s Japanese banks that may crack under US dollar funding strain 

Corporate profits are expanding at a solid pace after several years of contraction. As for the US dollar, higher interest rates could continue to fuel its rebound in the near term, but long-term fundamentals point towards a declining path over the next one or two years.

The US current account and fiscal deficit suggests the US dollar should be weaker. The Donald Trump administration’s “America first” policy does not explicitly support a weaker US dollar but has, in the past, expressed discontent at its excessive strength.

In Asia, many economies are running healthy current account surpluses to limit the threat of capital outflows. For those with current account deficits, such as India and Indonesia, their deficit position and foreign exchange reserves are meaningfully stronger today than in the past. 

Volatility is normal when it comes to investing in emerging markets, and understanding the long-term fundamentals always helps investors not to overreact and make rational decisions. Although investors should brace for a world of tightening liquidity and greater uncertainty, we remain quite far from a repeat of the 2013 taper tantrum scenario.

Tai Hui is chief market strategist for the Asia-Pacific at J.P. Morgan Asset Management