Emerging Markets Update: 2014 Looking Rough

Categories: Economics
A sign shows no currency exchange numbers outside a money exchange house in Buenos Aires, Argentina.

As the US Federal Reserve continues with its taper plans, it is clear the status quo is radically shifting — and not just in the United States. Because the monetary system is global, the status quo is shifting around the world. Upon announcing the possible taper in May of 2013, yield curves around the globe began a dramatic shift. The US 10-year Treasury bond yield has climbed from 2.6% or so before the taper announcement to about 3.0% since the taper actually began in December.

Perhaps the bigger story is that capital flows promptly reversed course. During the five years after the global financial crisis of 2008, capital flowed into emerging market countries that were benefiting from the massive influx of liquidity. Countries like Brazil, Russia, India, Indonesia, Malaysia, Singapore, and Turkey enjoyed a surge of capital inflows.

However, now, the taper is causing a regime change in the monetary system. Countries like India and Malaysia first experienced runs on their currencies last summer and fall in anticipation of the taper. Given their large current account deficits, it appeared that both countries would be prime targets for investors to exit in the face of imminent policy change. Then, in October 2013, Fed Governor Ben Bernanke announced the so-called “untaper,” which put the markets in a state of stasis — and the runs on Indian rupee and Malaysian ringgit stalled.

Then, of course, the Fed announced in December of 2013 that the taper was on. Most recently, the Fed announced last Tuesday that the taper will continue in February. So, in total from December to February, the rate of monetary expansion in the US has fallen from $85 billion per month to $65 billion per month (and appears to be slowly headed toward zero).

Since the taper was delayed, apparently India and Malaysia have stabilized. This situation is a bit puzzling because now that the taper is officially on, a number of other countries are experiencing sharp outflows of capital, such as Turkey, Argentina, and Venezuela. Just in the last few days:

While the magnitude of the impact of this regime change remains unknown, it is all too clear that the shift in US monetary policy is already having profound affects across the globe. It seems that capital is fleeing and interest rates are rising most sharply throughout the Emerging Markets. According to EPFR Global, emerging market equity fund outflows rose to $12.1 billion in the month of January. Emerging market bond funds lost about $2.7 billion last week alone. The outcome of this capital flight from emerging markets is either greater inflation or recession in many emerging market countries, perhaps both.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: AP Photo/Natacha Pisarenko

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8 comments on “Emerging Markets Update: 2014 Looking Rough

  1. Rohit Tuli said:

    A crisp wrap-up of the currency movements and traces towards a possibly greater level of inflation in the emerging markets and its effects due to the QE tapering. An interesting article. How do the central banks play on (reactive) to the QE taper, trying to maintain the status quo is whats going to be interesting to watch.

    • Rohit, thank you for your comments. I very much agree. Many emerging markets are in a real pickle (what we say in America for people in a difficult situation)! Should they try to retain/attract capital, they must raise rates. But if they do so, the economy will suffer. If they don’t raise rates, they escalate inflation. Of course, it’s not only US monetary policy that will influence their choices as well. Will Japan maintain aggressive QE? Will there be any structural changes in the euro – particularly as it affects Germany’s exports? How do individual emerging markets react? Russia for instance, has indicated that it is comfortable with a lower ruble, so looks like they are choosing inflation. But what about Brazil? India? Malaysia, Thailand, Viet Nam, etc.? We will learn a great deal in coming weeks. Stay tuned!

  2. Ankit Jain said:

    Good one Ron. I liked it. I expect that turmoil will for be there for two three months. Em markets currency will be stable thereafter. I dont expect much growth from Euro region, and us can grow with the range of 2-2.5%. India Central bank also raised Repo rate and msf by 25bps. It think Em should reduce their too much dependence on Foreign inflows and start investing their own money.

    • Hi Ankit! Thank you for your comments. It’s very interesting that India and Malaysia have more or less stabilized after the near crisis last summer/fall. For the moment, it appears that developed markets are mopping up the capital fleeing the EM’s. I think the extent of the problem could be worse. The easy money of the past 5 years has focused a good deal on EM’s. If there is a significant increase in interest rates, the economies will stall. And if the economies stall, I suspect we will discover that the misallocations of capital in EM’s has been very large. Where exactly they reside we won’t know for some time.

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  4. Pablo Matsumoto, CFA said:

    Good article. However, as regards Argentina situation, I strongly believe (as most local analysts do) that the reasons behind the recent strong moves in financial indicators are almost entirely local. Argentine economy has been almost closed from international markets since many years ago due to strong capital controls, and the recent spike in yields are related much more to a 20% Argentina peso devaluation triggered by local conditions (low levels of foreign reserves, heavy budget deficit financed by the central bank and heave expenditures is USD denominated energy imports) rather than from international reasons (i.e. tampering ).

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