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The sell-off in EM currencies since mid-April is not comparable to the 2013 taper tantrum. Has it gone too far?
Written by
Patrick Zweifel, Chief Economist
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In our view, the sell-off in EM currencies since mid-April is not comparable to the 2013 taper tantrum that was triggered by a classic balance-of-payments crisis. Rather, we think it is due to four global, idiosyncratic factors that impact the currencies of both current-account-deficit (CAD) and current-account-surplus (CAS) countries:
Rising global rates/stronger USD (affecting mostly CAD)
Trade tensions (affecting mostly CAS)
Renminbi (RMB) contagion (affecting CAS & commodity exporters)
Rising populism (affecting all)
Is the correction in EM currencies justified?
Observation 1 - A broad sell-off
EM currencies have lost 10 per cent this year, compared with 4 per cent in 2013 (Fig.1). The main difference with the 2013 taper tantrum is that the sell-off is broad-based, hitting both deficit and surplus countries.
Countries running a current account surplus have not been sheltered from the sell-off, but this is no contagion. We think it is due to trade tensions, and exposure to China and a weak renminbi.
Fig.1 - Both deficit and surplus countries have been hit this time round
USD vs. CAD & CAS emerging-market currencies (2018 vs. 2013 taper tantrum)
Source: Pictet Asset Management, CEIC, Datastream. 2018 data to 06.07.2018; 2013 data to 30.06.2014.
* 2018 CAD EM currencies: INR, IDR, PHP, ARS, BRL, CLP, COP, MXN, PEN, RON, ZAR, TRY. ** 2013 CAD EM currencies: INR, IDR, THB, ARS, BRL, CLP, COP, MXN, CZK, PLN, ZAR, TRY. *** 2018 CAS EM currencies: CNY, KRW, MYR, SGD, THB, TWD, CZK, HUF, ILS, PLN, RUB. ** 2013 CAS EM currencies: CNY, KRW, MYR, PHP, SGD, TWD, HUF, ILS, RUB.
Observation 2 - Current account positions are much stronger across the board than 5 years ago
Unlike 2013, there are significant differences between countries. While some EM currencies have outperformed the most resilient of the G10 currencies, the yen, the worst performers are four main deficit countries' currencies, led by the Argentine peso (Fig.2).
Fig.2 - Not all EM currencies have depreciated to the same extent
EM CAD & CAS countries' currencies change (YTD)
Source: Pictet Asset Management, CEIC, Datastream, July 2018
However, although countries with larger current account deficits (a proxy for higher external financing needs) typically have weaker currencies, not all CAD countries have seen their currencies depreciate as heavily this time. The main culprits are Argentina and Turkey, which exhibit genuine balance-of-payments fragility.
A point to note is that the two countries are the exception - current account deficit countries have sharply reduced their external financing needs, and appear much better placed to cope with higher rates.
Observation 3 - No contagion to fear from China
Admittedly linked to trade tensions, the weakness of the renminbi (RMB) comes after Chinese authorities allowed the currency to appreciate by some 4 per cent (Fig.3) versus its trade-weighted basket of currencies. We think it is a welcome catch-up against main trade partners.
Fig. 3 - Renminbi - back to January 2018 level
Renminbi vs. trade-weighted basket of currencies
Source: Pictet Asset Management, CEIC, Datastream. Data as at 11.07.2018.
A reassuring factor is that net capital outflows have been very limited year-to-date thanks to China’s improving fundamentals. Capital controls in place are also stricter since January 2017, notably on overseas direct investment, and this has reduced the risk of capital-flight panic.
Conclusion
Many emerging countries have reduced their current account deficit in recent years, putting them in a much better position to withstand external shocks. And although growth is slowing in China, its economy's fundamentals are stronger than in 2013.
Trade-related tensions remain, and the risk of a populist government is a concern in Brazil. But in our view, the correction in emerging market currencies has gone too far.
THE VIEW FROM OUR EMERGING CORPORATE BONDS TEAM
By Karen Lam, Senior Client Portfolio Manager
In our view, local currency depreciation is not necessarily bad for emerging market companies. As shown below, it depends on the sector. But more specifically, we think it is important to look at companies on a bottom-up basis.
Fig.4 - different Industries, different levels of vulnerability to depreciating currencies
EM corporate external bond stock - Industry breakdown
Source: J.P. Morgan, July 2018
For example, financial companies’ (including banks) foreign currency liabilities are generally matched with assets or hedged, making them less vulnerable to local currency fluctuations. Elsewhere in commodity-related industries, such as oil & gas and metals & mining, revenues are generally in hard currency.
On the other hand, sectors that derive most of their revenues from the domestic economy (e.g. consumer goods, telecoms and utilities) would be more vulnerable. Still, even for sectors that are traditionally seen to be ‘more vulnerable’, it depends on the individual company and bottom-up research is key (e.g. they may be hedged).
Based on our assessment, looking at sectors, we think at least 68 per cent of the investment universe should not be hit by depreciating local currencies.
CHART OF THE MONTH FROM OUR EMERGING MARKET EQUITY TEAM
By Avo Ora, Head of Asia (ex-Japan) Equities
Is China strong enough to face a war with the US?
Fig.5 - China is more important to US corporate sales than one could think
Source: Deutsche Bank, BEA, China Customs, IMF CDIS, 2017
Based on official figures, the US only exports USD150 billion worth of goods to China but imports nearly USD500 billion from China, suggesting that the US has the upper hand in any trade war.
However, these figures do not include goods that are assembled - but not produced - in China. Taking these into account, US business interests in China are far greater than the official data would suggest, as shown in Fig.5.
Intuitively, when we think about the smartphone production chain and where Apple iPhones are assembled for example – this is within Asia. This cannot move to the US without corresponding large price increases on iPhones and probably a reduction in quality. In this scenario, US companies and US consumers stand to suffer the most.
MARKET WATCH
Market watch data
30.06.2018
Source: Datastream, Bloomberg, data as at 30.06.2018 and in USD. Equity indices are quoted on a net dividend reinvested basis; bond and commodity indices are quoted on a total return basis. The currency rates evolution is treated as a performance calculation based on FX rates.
Cary Yeung, Head of Greater China DebtOctober 2019
About
Patrick Zweifel
About
Patrick Zweifel
Patrick Zweifel joined Pictet in 1997. He is Chief Economist at Pictet Asset Management. Before assuming his current position in 2009, he was head of the “Macro Research Team” at Pictet Private Wealth Management. In particular, he had economic research responsibility for emerging markets and Japan, and for the development of quantitative models on major asset classes, primarily foreign exchange models. Before joining Pictet he was a research assistant in econometrics and monetary theory and worked on international research projects for the World Bank and the European Union. He holds a PhD in econometrics from the University of Lausanne.
About
Karen Lam
About
Karen Lam
Karen Lam joined Pictet Asset Management in 2013 as a Senior Client Portfolio Manager in the Fixed Income Emerging Corporate team and is based in London.
Prior to joining Pictet Asset Management, Karen was an Executive Director at J.P. Morgan Asset Management working as a global rates portfolio manager and later as a senior client portfolio manager covering fixed income total return strategies and emerging market debt funds. Previously, Karen was the lead manager research analyst at J.P. Morgan Private Bank covering fixed income funds.
Karen holds an MBA from the University of Chicago Booth School of Business and an MSc in Epidemiology from Imperial College London.
About
Avo Ora
About
Avo Ora
Avo Ora has been investing in Asian ex-Japan equities for the best part of 20 years. This experience has shaped his way of looking at the market, which seeks to capitalise not only on the region’s structural growth prospects but also on cyclical opportunities. Having started his investing career at Putnam in Boston, Avo Ora joined Pictet Asset Management in 2011 and is the Head of the Asia ex-Japan equities team which includes the India and Greater China teams. Avo graduated from Clark University in Massachusetts with a BA in International Studies and also holds a Masters in International Affairs from the Columbia School of International Public Affairs.
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