Publications
Partners
New York - The selloff in emerging markets after Donald Trump’s US presidential election was intense. A closer look reveals that things aren’t as bad as they might seem.
While local-currency bonds suffered their biggest losses last week since 2008 following the Republican’s surprise victory, a gauge of volatility in developing-market currencies remained 16% below the levels seen in February. The cost to hedge against foreign-exchange losses is 38% cheaper than it was in August 2015 when China’s yuan devaluation rattled global investors.
In a global bond selloff fuelled by expectations that Trump will increase government spending, emerging-market traders are by no means capitulating. While bracing for the risks of protectionist policies, they’re betting faster growth and narrowing current account deficits will help most developing countries weather the rout.
The recent declines have “created a great buying opportunity,” said Koon Chow, a strategist at Union Bancaire Privee Ubp SA in London. “We could get to the stage where, in one or two weeks’’ time, US Treasury yields stabilise, and if that happens, emerging markets will come back.”
While it’s too early to call a bottom, Chow said domestic bonds in Brazil and Russia start to look attractive, together with the Colombian and Peruvian currencies. Asian exchange rates are likely to remain under pressure, he said.
More than $1.2trn was wiped off the value of global bonds last week as Trump’s win bolstered the view that a government spending splurge may accelerate US growth and inflation. Emerging markets were among the hardest-hit as the real-estate mogul pledged on the campaign trail to pull America out of the Trans-Pacific Partnership, brand China a currency manipulator and build a wall along the border with Mexico.
Restrained selling
Since the November 8 election, developing-nation local-currency bonds have tumbled 7.3% through November 11, the biggest three-day slump since October 2008. The decline cut the bonds’ return this year to 8.5%. Investors yanked a record $301m from BlackRock’s $8.9bn emerging-market fixed-income fund on November 10.
In the currency market, Mexico’s peso plunged 12% to a record low while the Brazilian real and South Africa’s rand have lost more than 6%. The rand was trading 1.8% lower on Monday by 06:30 at R14.34/$.
The selling also extended to Asia on Monday. The Malaysian ringgit sank 0.9% to a nine-month low and South Korea’s won depreciated 0.5% to the weakest since June. The Indonesian rupiah extended declines after falling as much as 3% on Friday, the most on an intraday basis since September 2013.
Bank Indonesia said on Friday it was in the market to stabilise the rupiah, adding that outflows were moderate and it expects the slide to be temporary. Bank Negara Malaysia said the monetary authority’s role is to continue managing “extreme volatilities in the ringgit, with no targeted level.” Indian state-run banks sold dollars on behalf of the Reserve Bank, according to two Mumbai-based traders, who asked not to be identified.
Still, there are indications that the selloff may be limited. While hedging costs in the currency market increased to a five-month high of 4.3% on Nov. 10, they were lower than those of 6.9% in August 2015, according to data compiled by JPMorgan Chase. At 11.3%, JPMorgan’s gauge of currency volatility is below this year’s high of 13.4% set in February.
Stronger fundamentals
One reason is that emerging countries are on a stronger footing now compared with three years ago during the so-called taper tantrum when then Federal Reserve chairperson Ben Bernanke’s signal to reduce monetary stimulus sent a shock wave through global markets. Developing-nation local-currency bonds lost about 16% in less than four months.
Economic growth is picking up this year for the first time since 2010 with Brazil and Russia digging themselves out of recessions, the International Monetary Fund estimates. The average shortfall of current accounts in South Africa, Brazil, Turkey, India and Indonesia, a group branded as the “fragile five” by Morgan Stanley in 2013, has shrunk to 2.4% of gross domestic product, from a record 5% in 2013, according to data compiled by Bloomberg. Foreign reserves have increased in countries including Indonesia and India, providing them with ammunition to defend their currencies.
“Fundamentals are much stronger than going into the taper tantrum.” said Paul McNamara, a money manager at GAM UK Ltd. The selloff “just strikes me as a little bit extreme,” he said.
Strategists at Morgan Stanley and Citigroup warn that the rout is likely to deepen. Trump’s protectionist overtures, if acted upon, would slow exports from and reduce investments to developing markets, they say.
In addition, central banks in the US, Europe and Japan are either ready to raise borrowing costs or stop easing further, dragging Treasuries yields up and putting pressure on emerging markets, Citigroup’s analyst Dirk Willer wrote in a note on Friday. Local debt in Mexico, Poland and Hungary are most vulnerable to rising US yields, he said.
Analysts at Morgan Stanley estimate that investors are overweighting domestic bonds and have hedged between about 10% and 30% of their currency exposure in Brazil, Indonesia, Russia and South Africa. If the selloff extends, investors may have to cut their holdings and increase their purchases of insurance, exacerbating the decline.
For now, McNamara said he’s willing to give Trump the benefit of the doubt. He’s looking to buy the South African rand once there’s some clarity about the direction of the new US government.
“We just sit tight at the moment,” said McNamara, whose Julius Baer Local Emerging Bond Fund returned 13% this year. “All the negative is based on various assumptions. We’ve got very little hard evidence in terms of what the new administration is going to mean for emerging markets.”
