A panic attack in the developing world as emerging markets sell off

Investors once attracted by exotic growth stories have fled higher-risk emerging markets.

"The salad days for emerging markets are over," says the Financial Times. Last week saw a bout of "near-panic" as investors once attracted by exotic growth stories fled back to traditionally less-risky assets in the developed world.

US government bond yields fell (so prices rose) and the Japanese yen strengthened, as a Bloomberg index of 29 emerging-markets currencies fell to its lowest level since April 2009.

The Argentinian peso fell 12% last Thursday alone to a record low against the US dollar. The Turkish lira also hit yet another record low against the greenback, while the South African rand fell to its lowest point in five years.

Stock markets have also fallen hard. The MSCI Emerging Market Index, having dropped by 4% in as many days, is now down almost 6% for the year. Funds tracking Chile and Brazil slumped by over 5% last week. The jitters also engulfed developed stock markets.

A toxic cocktail of worries

Recent economic data suggests that manufacturing activity is shrinking. There was also the near-default of a trust loan (a high-yielding investment product sold to wealthy individuals, with the money used to fund business projects) that reminded investors of all the dodgy loans lurking in the shadow banking system, which made up a third of total credit last year.

China's slowdown has hit confidence in emerging-market growth, especially commodity exporters.

Investors are also nervous, because it's clear "the rich world's central bankers do not have much of a clue how to tame the beast they have created in the form of ultra-loose monetary policy", says Economist.com's Free Exchange blog.

Last week, the Bank of England all but abandoned the forward guidance' framework it put in place only six months ago, because unemployment has fallen much faster than expected.

No one is sure when Western central banks will raise interest rates. But when they do, higher rates will likely attract money away from risky assets such as emerging markets as the West becomes more attractive.

"Normalising central banks' balance sheets is going to be mightily unpredictable and disruptive," says the Free Exchange blogger.

Is this the start of a crisis?

There has long been downward pressure on the peso as the market has tried to price in this poor macroeconomic backdrop. Last week, the government bowed to the inevitable and stopped spending its dwindling foreign-exchange reserves on propping up the currency.

Similarly, Turkey's government has put pressure on the central bank not to raise interest rates to stem the slide in the lira. This has made investors worry all the more about Turkey's current-account deficit a classic emerging-market weak spot, as we explained last week.

Still, investors "shouldn't rush to assume a new crisis is underway", says Richard Barley in The Wall Street Journal. In a classic emerging-market crisis, states with the same or very similar problems all slump like falling dominoes. This time the markets are suffering from a wider range of local problems.

In any case, they look less shaky than during their last crisis in the late 1990s, as they have built up foreign-exchange reserves, are borrowing less in foreign currencies, and have flexible rather than fixed exchange rates.

This flexibility makes it easier to adjust gradually to slowdowns, or money fleeing back to developed markets. And the selling makes our favourite emerging markets, including Mexico and South Korea, look better value.

Recommended

I wish I knew what an emerging market was, but I’m too embarrassed to ask
Too embarrassed to ask

I wish I knew what an emerging market was, but I’m too embarrassed to ask

This week's “too embarrassed to ask” explains what emerging markets are, and why you might want to invest in them.
9 Sep 2020
Bullish investors return to emerging markets
Stockmarkets

Bullish investors return to emerging markets

The ink had barely dried on the US-China trade deal before the bulls began pouring into emerging markets.
27 Jan 2020
Beware the hidden risks when investing in emerging markets
Investment strategy

Beware the hidden risks when investing in emerging markets

Emerging markets look cheap compared with developed countries, but earnings may be less trustworthy.
23 Dec 2019
The British equity market is shrinking
Stockmarkets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019

Most Popular

Will a second wave of Covid lead to another stockmarket crash?
Stockmarkets

Will a second wave of Covid lead to another stockmarket crash?

Can we expect to see another lockdown like in March, and what will that mean for your money? John Stepek explains.
18 Sep 2020
Here’s why you really should own at least some bitcoin
Bitcoin

Here’s why you really should own at least some bitcoin

While bitcoin is having a quiet year – at least in relative terms – its potential to become the default cash system for the internet is undiminished, …
16 Sep 2020
IAG's share price is ready for take-off - here's how to play it
Trading

IAG's share price is ready for take-off - here's how to play it

The owner of British Airways has had a turbulent year, but is now worth a punt. Matthew Partridge explains the best way to play it.
8 Sep 2020