Investors in emerging markets brace themselves for turbulence

Strong US dollar prompts wave of selling in currencies, stocks and bonds

During the “taper tantrum” of 2013 emerging market securities suffered as investors feared a stronger dollar would make dollar debt harder to repay

Emerging markets investors are braced for turbulence in the coming days following last week’s sharp currencies sell-off that led to drastic measures by Argentina’s central bank to stop a slide in the peso.

Markets have been roiled by a stronger US dollar, which has prompted a wave of selling in emerging market currencies, stocks and bonds.

Argentina, which is struggling with high inflation and large deficits, responded to the hit on the peso last week by raising interest rates three times – from 27.25 per cent to 40 per cent.

The “paradigm shift” of a stronger dollar could trigger a bigger and longer-lasting emerging markets sell-off, warned Sonja Gibbs, senior director of the Institute of International Finance, an industry association.


“If you look at the futures market for the dollar and US Treasuries, short positions are at very high levels, akin to the taper tantrum,” she said, referring to the developing markets shake-up in 2013 when the US announced an end to ultra-loose monetary policies.

“If the dollar continues to strengthen we will get to a point where those are very painful and the risk is they will have to unwind,” Ms Gibbs added.

Dollar debt

During the “taper tantrum” of 2013 emerging market securities suffered as investors feared a stronger dollar would make dollar debt harder to repay. Since then many emerging markets have improved their government finances, but corporate debt levels – both in local currency and dollars – have continued to rise.

Argentina’s woes have been shared by other countries in the region, with companies from Argentina, Colombia and Paraguay scrapping plans to issue $2 billion (€1.67bn) in bonds last week because of rising US interest rates, according to Bloomberg.

The hit to emerging markets currencies has affected countries from Turkey to Poland. While the lira has been driven lower by concerns over Ankara’s economic imbalances, the zloty has been caught up in the wider sell-off despite a more stable economic situation in Warsaw.

However, some analysts said the extent of the damage may be limited because of better macro-economic conditions in developing countries in recent years.

Paul McNamara, a fund manager at Gam, said there was potential for a milder echo of the taper tantrum – but only on the currency side.

“I think the fundamentals are different now, and the currencies that have been hit the worst are the ones with big current account deficits. I’m willing to defend the idea that this time really is different.”

Higher interest rates

Sergio Trigo Paz, head of EM fixed income at BlackRock, the world’s biggest asset manager, said some emerging countries wishing to issue debt this year would have to pay higher interest rates than planned, but this would offer investors the chance to switch into higher-yielding assets.

Yet the outlook for emerging markets may be determined by conditions beyond their control. Simon Quijano-Evans, EM strategist at Legal & General Asset Management in London, said a combination of more assertive US foreign policy, leading to higher oil prices, and continued dollar appreciation would be “a double whammy” for emerging market currencies.

“All eyes are on one thing, which is US policy, and the impact of that on the performance of the dollar,” he said. – Copyright The Financial Times Limited 2018