Is the indiscriminate selloff seen in emerging markets in recent weeks really a replay of 2013’s ‘taper tantrum’ or a good buying opportunity, wonders Delphine Arrighi, a fund manager at Old Mutual Global Investors. Sentiment decidedly worsened in May, leading to another sharp correction across emerging markets. The magnitude of the correction has led some to draw parallels with the taper tantrum of 2013, when the US central bank signalled it would start reducing monthly bond purchases far sooner than the market expected.
Indeed, emerging market currencies have lost more than 6% in the last two months, compared with a decline of 7% in the taper tantrum that lasted for five months. Furthermore, the hard-currency bond index is
down close to 5% this year versus a fall of 11% in May-September 2013.
The tightening of global financial conditions and a stronger US dollar have created some headwinds for emerging market prospects, that otherwise remain supported by relatively sound fundamentals. The market has weighed heavily on those countries that are perceived as the most vulnerable to a rise in the cost of external funding, including Argentina and Turkey.
ARGENTINA: IMF TO THE RESCUE
The authorities in Argentina were prompt to respond – delivering a staggering 1,275 basis points of rate hikes in a week to a record 40% and a firm commitment from the government to accelerate the pace of fiscal consolidation while also embarking on negotiations with the International Monetary Fund (IMF). Those negotiations took less than a month and
resulted in a remarkable stand-by agreement of US$50bn over three years – well above market expectations of US$30-40bn, with little economic adjustment from what the government had already put forward. And yet, the market failed to react positively to the news.
The outlook for Argentina remains challenging, with a risk of lower growth potentially leading to lower revenues and
depressed confidence locally, jeopardising the re-election of president Mauricio Macri in the 2019 elections. But market pessimism looks overdone. The US$50bn IMF stand-by agreement and US$6bn of additional debt from other international financial institutions provides a credible backstop for the Treasury’s liquidity while covering most of Argentina’s financing needs until 2020. This year’s fiscal target should easily be met with the government forecasting a conservative growth rate of 0.4%, allowing for some extra saving to be rolled over into next year where a primary
fiscal deficit target of 1.3% could prove more challenging.
The IMF package, along with the recapitalisation of the central bank, should also help provide some near-term stability to the exchange rate, which in turn should lead to a resumption of portfolio inflows. As such, the IMF package is a credit positive for Argentinean assets.
BRAZIL: UNJUSTIFIED GLOOM
Brazil is another country where pessimism seems overdone. While market pressure in Argentina and Turkey has forced their central banks into emergency rate hikes, similar hikes look unjustified in Brazil where the current account deficit has narrowed substantially. A weaker real and less market-friendly political developments after a recent truck drivers’ strike have led the market to price in close to 200bp of rate hikes. Meanwhile, inflation still hovers around 2.5%, well below the central bank’s 4% target, and recovery remains sluggish ahead of presidential elections in October. The inflationary impact of the strike, albeit temporary, could eventually lead the central bank to hike rates by 50bp in June, which would put Brazil cost of carry more on par with its high-yielder peers like Mexico and so make the real less vulnerable to market pressure.
So far, the central bank has chosen instead to rely on increased FX swap sales to curb the currency’s weakness, a policy move that we think credible and more appropriate to the domestic economic backdrop. Meanwhile, the market’s negative reaction to a more populist candidate like Jair Bolsonaro leading in the polls seems overdone. After all, the uncertainty surrounding his economic proposals is fairly similar to that associated with Andres Manuel Lopez Obrador in Mexico, where the market’s reaction to his likely presidential victory at the polls in July is much more subdued.
Clearly Brazil’s fiscal challenges are much more severe than those faced by Mexico and signs that a pro-reform candidate is leading the polls would help restore some confidence in the market. With elections more than four months away and party conventions – where the centre coalition could elect a stronger candidate – taking place at the end of July, the presidential elections are far from a done deal. As such there is room for the political outlook to improve in the coming months and in turn make Brazilian rates more attractive.