Back to school and back to the markets. In this update we drill down on the key drivers behind recent volatility in emerging market (EM) currencies–most notably the Turkish lira and Argentine peso– and outline what we are monitoring for the seasons ahead. Please see below for a summary.
A combination of a moderation in global growth (as last year’s strong and synchronous growth backdrop motivated robust inflows into EM assets), withdrawal of global liquidity and tighter financial conditions (with the Fed set to raise rates a total of four times this year), political uncertainties which has led to bouts of risk-off investor sentiment, and higher oil prices which can be challenging for net-commodity importing economies.
Country-specific events including US sanctions on Russia, concerns around external funding needs in Turkey and Argentina, and doubts around economic reform progress in South Africa. Intensification of US-China trade tensions also weighed on the Chinese yuan and currencies from countries geared toward Chinese growth.
Unorthodox macroeconomic policies have led to macro imbalances, such as above-trend growth, above-target inflation and a wide current account deficit. In August, a diplomatic dispute with the US resulted in targeted tariff and sanction actions and led investors to question Turkey’s ability to finance its wide current account deficit.
1) Policymaker actions including monetary tightening, commitment to fiscal discipline, acceptance of economic rebalancing and capacity to recapitalize the banking and corporate sector (should they encounter funding pressures); 2) banking sector stability including the ability of Turkish banks to rollover external debt in the coming months; and 3) current account adjustment which will in part occur due to market forces as currency weakness and a slowdown in domestic growth will likely compress imports while boosting export competitiveness.
Macro imbalances such as a wide current account deficit means Argentina is sensitive to global liquidity conditions and investor perception of policymaker credibility. Against a backdrop of developed market monetary tightening, Argentina’s ability to access capital from foreign sources to meet its funding needs has fallen. This prompted President Mauricio Macri to request the International Monetary Fund (IMF) to accelerate disbursement of a loan worth up to $50 billion in order to meet its debt obligations.
1) Policymaker actions including fiscal and further monetary tightening (the central bank has already raised rates by 31.25% this year); 2) current account adjustment which should occur as growth moderates and the impact of a loss in agricultural export revenue due to a drought earlier this year abates; 3) IMF support and in particular clarity around timing and magnitude of its aid package; and 4) domestic stability given a loss of confidence in institutions among domestic consumers, businesses, investors and savers.
Economic fundamentals for majority EM economies are healthy; current account imbalances and growth-inflation dynamics have improved in recent years. That said, we recognize EM is a diverse opportunity set and so risk and opportunities vary by country. Near-term patience may be required when assessing value and the potential for rebound in EM assets. However, we believe medium- to long-term structural tailwinds– strong growth potential, favorable demographics, low debt, better balance sheet resilience and corporate earnings growth potential – remain intact. Importantly, we do not think recent country-specific events should serve as a bellwether for the broader EM complex and we continue to see investment potential across EM markets.
