It’s ugly out there.
Even after Thursday’s 175-point (1%) plunge in the Dow Jones Industrial Average, markets continue to tumble.
Currently, the Dow is down 260 points (1.6%) and the S&P 500 is down 31 points (1.7%).
Investors and traders are rapidly moving from risky assets like stocks and emerging market securities to safe assets like U.S. Treasury securities. Indeed, the flood into Treasuries has sent the yield on the 10-year note all the way down to 2.72%. Not long ago, it was above 3%.
Asia got slammed with the Nikkei tanking 1.9% and Hong Kong’s Hang Seng falling 1.2%.
Europe closed deep in the red with Britain’s FTSE 100 down 1.6%, Germany’s DAX down 2.4%, France’s CAC 40 down 2.8%, and Spain’s IBEX down 3.6%.
The top concern today seems to be the emerging market economies, where it is a total rout in the currency markets. The Turkish lira tumbled 1.6% to a record low of 2.3360 per dollar. South Africa’s rand is at a 5-1/2 year low.
Meanwhile, it’s continued madness in Argentina where policymakers unexpectedly announced an easing of capital controls a day after the Argentine pesos (ARS) plummeted 13%.
Why are the emerging markets getting slammed?
“There is no single proximate cause, in our view, rather the cumulative impact of a number of events has led to a deterioration in risk sentiment,” said Morgan Stanley’s Rashique Rahman. “Growing concern over China’s macro trajectory and uncertainty over credit risk in China’s trust and wealth management products are probably the main drivers, but contributing factors to the spillover into other markets include Turkey’s ongoing currency volatility and political concerns, weakness of Ukrainian credit markets and the ARS devaluation.”
How The Federal Reserve Plays Into This
In addition to these local stories, there’s also the big macro story related to U.S. monetary policy.
Many of the fast-growing emerging market economies continue to be heavily dependent on their ability to export goods. However, they have also been confronted by devaluing currencies and rampant inflation, which also hinders their ability to finance their overseas obligations. And with the U.S. Federal Reserve expected to soon normalize monetary policy, there is concern that rising interest rates and a strengthening dollar against emerging market currencies will send the emerging markets toward a financial crisis.
Bloomberg LP Chief Economist Michael McDonough tweeted the chart above showing how emerging market currencies began tumbling as U.S. interest rates rose and the dollar strengthened.
Also, The Bank Of England, The Swiss National Bank And The Bank Of Japan
As the Fed and the emerging market central banks worry about their currencies, the rest of the developed market’s central banks are also chiming in. Like the Fed, they are adopting a tone that could mean stronger local currencies, which would put more pressure on the emerging markets.
From Citi’s Steven Englander:
EM currencies are feeling the pain but the driver is investor fear of a sudden lurch to hawkishness among G10 central banks. Consider the list below of G10 drivers of liquidity concerns:
1) Market worried about Fed tightening and Fed forward guidance.
2) Strong U.K. data and BoE hawkish tilt.
3) BoJ member talking about no additional easing and ultimate QE exit.
4) SNB macroprudential move on housing.
Emerging Markets Are Losing Out To The Developed Markets
“Productivity is critical to compete globally, and many emerging markets offered manufacturers greater profitability through productivity,” said market strategist Rich Bernstein. “However, productivity growth is now slowing meaningfully in most emerging markets, and the emerging markets now have the highest inflation rates in the world.” (See chart below.)
“When productivity fails to be a competitive advantage, then countries have to compete purely on price and devalue their currencies,” he added. “Devaluing a currency often results in higher inflation rates because the prices of imported goods, both input raw materials and consumer goods, go up. Emerging markets’ current high inflation rates will likely limit emerging market countries’ exchange rate flexibility. Some EM countries are already starting to lose market share as a result.”
It’s quite the pickle. While there may be some economic activity that gets shifted from the EMs to the DMs, in the short-run all of this market volatility will be bad for everyone.