The MSCI Emerging Markets Index is Trending Lower!
Emerging Market Currencies under Fire Ahead of Next Fed Meeting
September and October were wretched months for emerging market currencies. Despite inaction by the Fed in September and again in October, anxiety is pervasive across emerging market economies. The vulnerability of emerging market currencies has heightened as a result of an economic slowdown in China. That China is the world’s second largest economy and the number one trading partner with the majority of emerging market nations is a worrying factor. The Chinese economic contraction in September, year-on-year, resulted in declines in imports of 20.4% and exports over the same period were 3.7% lower too. The 20.4% drop placed the import total at $145.22 billion as at September 2015. During August, Chinese imports slipped by 13.8% year on year. Another decline in October will herald 12 consecutive months of year-on-year declines for the world’s largest commodity consumer. The vast majority of China’s imports are electromechanical products, at 43% of total imports. China’s insatiable appetite for Crude oil accounts for 12% of all imports every year, with iron ore weighing in at 5% and other metals including aluminum and copper ranking high on the list The October data for China’s imports is slated for release on the 8 November and the consensus forecast is a year-on-year decline of 15%.
While the declines are significant, the effect is felt more by emerging market countries which are responsible for supplying China with these commodities. Countries across Africa and South America have been deeply hurt by the declining demand from China. This is evident in sharp cutbacks in output, declining revenues and profitability, the layoff of workers, and the shuttering of operations in multiple countries. For example Glencore PLC has temporarily shuttered copper mines in the Democratic Republic of Congo and Zambia. The Eland platinum mine in South Africa was recently closed too. These initiatives are being undertaken to divest from poorly performing business units and to decrease the global supply to ramp up the price of commodities. Copper, Crude Oil, Iron Ore and other commodities have been hard-hit by China’s stock market crash. Over $5 trillion was wiped out from equities markets and this resulted in a massive stimulus initiative by the Chinese government on multiple fronts. A 2% depreciation of the CNY, massive expenditure on blue-chip shares, monetary easing and other measures have been adopted to reignite a flailing Chinese economy. The Chinese economy has moved away from an export-driven model to a consumer-focused service economy. During the transition, we have seen massive declines in manufacturing and this is a result of high levels of inventories being depleted which is keeping manufacturing at low levels.
How Are Emerging Market Currencies Doing?
The dual effect of a China slowdown and a Fed rate hike are weighing heavily on EM economies. For countries like South Africa, Brazil, India, Russia, Venezuela and others the latter half of 2015 has been difficult. Banc De Binary analysts have seen a heavy weighting of put options on EM currencies of late. This dovetails with market sentiment vis-à-vis the performance of emerging market currencies like the South African rand, the Venezuelan Bolivar, the Turkish lira and the Russian ruble, et al. A great way to gauge the sentiment of emerging market currencies is the MSCI emerging markets index. This index has trended strongly lower since May 2015 where it was priced around $1,067. It has since dropped to a November 4 price of $868. As can be expected, there have been concomitant currency declines in the exchange rates of the many emerging market currency pairs with the USD. Dollar strength has been notable throughout the year, with particularly strong performance expected in the run-up towards the December 15/16 Fed FOMC meeting.
The percentage likelihood of a Fed rate hike has swelled to 58% for December. As it stands, EM currencies are depreciating sharply and bond yields are rising. This is to be expected given an imminent rate hike. Among others, the Malaysian ringgit and the Russian ruble led declines. After the Fed chair’s testimony on Wednesday 4 November, the yield on the 2-year Treasury note spiked. The Chinese steel industry is under tremendous pressure, owing to several years of surplus production. However, the Chinese government has been hard at work bolstering the economy following the $5 trillion rout in equities. A series of measures has been implemented and we are already starting to see the benefits of Chinese policies taking root. These included a 2% devaluation of the CNY, massive purchases of blue-chip equities, investment funds, monetary easing and a sixth interest-rate cut among others. China is also fixing to become the 5th country to enter the elite IMF SDRs club as one of the world’s reserve currencies. The Shanghai Composite Index is now rallying and various commodities have been enjoying a short-term bull run. Overall though, there has been significant damage done to mining stocks in 2015 and the likes of Anglo American, BHP Billiton, Rio Tinto and Glencore PLC have been hit hard.
Fed Hike is More Likely in December
The likelihood of a December rate hike is higher now given the fundamentals of the US economy. Speculation of a rate hike drives up anxiety levels in the markets, fueling selloffs of EM currencies. Binary options traders have been particularly bearish on these currencies and will continue to be leading into December. The general consensus among economists is that the chips are falling into place for a rate hike in December and all the data supports this. As further evidence of market sentiment, the US Dollar Index gained 0.1% by 7 am on November 5, 2015 and the greenback has been trading at its strongest levels against the EUR and other currencies. The RUB lost 1.3% and the Korean won slipped 0.6% too. Capital flight from EM economies is increasing in the lead-up to the Fed decision (EM countries are perceived as highly volatile) and even the GBP slid amid reports from the Bank of England about growth projections for the coming year. As far as the MSCI emerging markets index is concerned, declines are widespread from Thailand through Turkey and beyond. It is clear that dollar strength will persist while weakness pervades other markets.