The brief reprieve in emerging markets is over, cancelled out by a sharp reminder from the US that nobody should be betting on low rates to last for ever.
As markets absorbed the US Federal Reserve’s April meeting minutes published last week and realised that a summer rate rise was back on the table, a “risk-off” trade took hold that pushed the dollar up and sent commodity and equity prices down.
Amid the sell-off, the fledgling rebound in emerging market currencies, stocks and bonds that surprised investors in March and April ground to a halt.
MSCI’s emerging market share index fell almost 3 per cent last week, taking the index negative for 2016. Major currencies including Russia’s rouble, South Africa’s rand and Turkey’s lira have weakened against the dollar and average EM country borrowing rates are at a month-high.
Investors profess themselves unsurprised. After years of underperformance, it will take more than a two-month rally to counter their misdoubts.
“The rally in March and April was only ever about short-covering,” says Bryan Carter, head of emerging market fixed income at BNP Paribas Investment Partners. “Investors were so pessimistic about a long period of bad headlines and weak data that they were severely underweight by the start of the year. All they did was go from underweight to neutral.”
Data from JPMorgan show that even this move was less than wholehearted. The share of emerging market equity exchange traded funds as a percentage of all equity ETFs remained low even in the midst of the rebound — at about 9 per cent of the total, from 20 per cent in 2013.
Google parent Alphabet briefly became the world’s most valuable publicly-traded company by market value on Thursday as the sell-off in Apple’s shares this year continued.
Apple’s shares dropped as much as 3 per cent on Thursday, extending the iPhone maker’s drop this year to 14.7 per cent, and bringing its market value down to $492.2bn.
The shares of Alphabet, meanwhile, were little changed, leaving the California-based company’s market value at $492.6bn.
The last time Alphabet’s market value topped Apple’s on a closing basis was on February 2, according to Bloomberg data. However, Apple had managed to regain its lead until Thursday.
Apple’s shares have been hit hard by worries that sales of the iPhone, its flagship product, may start to wane as consumers in developed markets find fewer reasons to upgrade their smartphones, and a slowdown in major emerging markets, like China, reduces demand.
That is looking to be the case for emerging market investors, with Fed comments over the possibility of a rate hike in June triggering a wave of profit taking across the asset class this week.
Emerging market currencies retreated for a third straight day and EM stocks fell to a one month low on Wednesday after Dennis Lockhart, the Atlanta Fed president, said on Tuesday that an interest rate increase next month remains a “real option”.
Having rallied some 10 per cent from its January lows to hit a six month high on Monday, JPMorgan’s EM currency index is down more than 2 per cent this week after falling another 0.3 per cent on Wednesday.
The foreign ministers of China, Russia and India have issued a joint communiqué calling for further reforms at the International Monetary Fund granting emerging economies a greater voice.
The joint statement follows the close on Monday of the 14th Russia-India-China Foreign Ministers Meeting held this year in Moscow.
In it, the countries’ ministers welcomed implementation of draft reforms from 2010 meant to raise quotas and reallocate voting shares at the IMF to grant developing countries a greater role in international monetary policy. Conditions for implementing those reforms were only satisfied in January after half a decade of delay.
But the ministers went on to call on the IMF to push forward with further reforms to give emerging markets and developing nations greater representation and more say at the Fund “as quickly as possible”.
The communiqué, released in full today on the official website of China’s Ministry of Foreign Affairs – though at present available only in Chinese – also called for greater international and regional coordination by the three nations and reaffirmed China and Russia’s support of India’s desire for a greater role at the United Nations.
Fitch Ratings has made widespread downward revisions to growth forecasts in its latest Global Economic Outlook (GEO). While the biggest revisions have been to emerging market commodity producers – namely Brazil, Russia and South Africa – there have also been sizeable revisions in advanced economies. The breadth of the revisions is notable; however, it still leaves the growth outlook considerably above global recession territory.
“The investment slowdown in China and sharp expenditure compression in major commodity producing countries continue to reverberate around the world economy,” said Brian Coulton, Chief Economist at Fitch.
Using our “Fitch 20”, a proxy for world GDP based on a weighted average of 20 of the largest advanced and emerging market countries, we forecast growth in advanced countries as a whole at 1.7% in 2016 down from 2.1% in December’s edition of the GEO. For emerging markets, 2016 growth is now pegged at 4.0%, down from 4.4% in December. The equal revisions for both the advanced and emerging country aggregates breaks the previous pattern of forecast changes, whereby weakening emerging market prospects were associated with much smaller downward revisions to the advanced country outlook. This reflects the fact that external and energy sector shocks are now having a clearer negative impact on advanced economy growth than previously anticipated.
Commodity prices have plunged; the decline has accelerated over the last year. Currencies have witnessed devaluations, and stocks and bond routs have prevailed across most emerging markets; capital outflows have hit some $735 bln in 2015; $448 bln in outflows are expected this year. Overall, during 2015-2016, safe-haven assets in advanced nations will attract about $1.2 trln in investment, as estimated by the Washington-based Institute of International Finance. Bucking the trend, US Treasuries are rising in price, causing a decline in yield and intimidating US growth prospects, while one of the least likely safe-haven assets, the Japanese yen, is rising against the dollar, harming the nation’s exporters.
Imbalances in international capital flows are being exacerbated amidst the developing nations’ gloom as the slump in commodities, economic and political mismanagement and corruption have triggered massive outflows, with investors seeking safer assets in developed markets. An influx of some $735 bln in capital in 2015, with another $448 bln due in 2016, is hardly good news for the advanced economies, as the abundance of international investment is heating up the hottest sectors, like banking and overall finance, barely reaching the real economy.
Consequently, the global capital flows’ discrepancy might trigger dangerous imbalances within the advanced economies.
In 2015, China alone lost some $676 bln of investment capital, according to IIF data. IIF’s previous estimates placed the total amount of emerging markets outflows for 2015 at some $348 bln, but the actual number turned out to be about twice that much.
The number of jobless people in the world is set to rise this year, as problems in emerging markets prevent the global unemployment rate from returning to pre-crisis levels.
The International Labour Organisation, a UN agency, forecasts that the number of unemployed people in emerging and developing countries will increase by 4.8m in the next two years.
In particular, rising jobless numbers in China, Brazil, Russia and elsewhere will offset improvements in the US and Europe, it says. The ILO’s annual employment report warns will such problems will hold back the expansion of the middle class and risk fuelling social discontent.
“The significant slowdown in emerging economies coupled with a sharp decline in commodity prices is having a dramatic effect on the world of work,” Guy Ryder, the ILO’s director general, said.
The rise in the number of the world’s jobless from 197m in 2015 to 199m this year, would keep 2016’s global jobless rate at 5.8 per cent — the same as the last two years — because of population growth.
Some ‘aches and pains’ are constraining the global economy, with JPMorgan warning of more severe strains occurring in the emerging world. These aggravating but generally not life-threatening conditions are meant to convey a slow growth world, but, JPM is careful to note, not one on the immediate precipice of collapse or recession.
The key issue for 2016 then is whether economic illnesses in emerging markets will result in contagion in the developed world as “dollar altitude sickness” and “earnings anemia” do little to support the domestic ‘immune’ system.
Every year, roughly $1 trillion flows illegally out of developing and emerging economies due to crime, corruption, and tax evasion. This amount is more than these countries receive in foreign direct investment and foreign aid combined.
This week, a new report was released that highlights the latest data available on this “hot” money. Assembled by Global Financial Integrity, a research and advisory organization based in Washington, DC, the report details illicit financial flows of money from developing countries using the latest information available, which is up until the end of 2013.
Rating agencies do not systematically discriminate against emerging market countries by unfairly awarding them lower credit ratings than developed nations, according to analysis published by the Bank for International Settlements.
Emerging market governments and investors have long argued they are the victims of an ingrained bias against them by Fitch Ratings, Moody’s Investors Services and Standard & Poor’s, the three US-based agencies that dominate the sector.
In particular, they argue it is wrong that EM sovereigns typically have a lower credit rating than developed world governments despite, in most cases, having a lower debt burden as a proportion of gross domestic product.
Analysis by Frank Packer of the BIS and Marlene Amstad of the Chinese University of Kong Kong, Shenzhen, demonstrates clearly that EMs tend to have lower ratings than developed economies despite being less indebted.