This week was terrible for emerging markets.
Investors pulled $US9.3 billion from emerging market funds — the most since the financial crisis 2008.
It almost feels a little like 2013, when the Fed warned of the ending of its quantitative easing bond-buying program and emerging markets suffered a massive outflow of funds back into US bonds in what’s now called the “taper tantrum.”
Some experts anticipate we could relive that move once the Fed begins raising US interest rates.
But not quite yet.
Ankur Patel, chief investment officer at R-Squared Macro, says there are a number of factors that played into this week’s shock, and the Fed is only one of them. Those include:
The majority of this week’s outflows (about 70%, according to Patel) came from one country: China.
That’s most likely due to the global index compiler MSCI’s decision not to include Chinese shares in its benchmark index this week.
Billions of passive money dollars would have been “forced” to buy Chinese shares if they had been included, according to the Financial Times.
2. The World Bank
Also earlier this week, the World Bank downgraded its 2015 growth outlook for global markets, including emerging markets. It warned that emerging markets, which had helped drive global recovery for years following the financial crisis, are now facing a “structural slowdown.”
“Anytime there’s a big multinational agency that has a downgrade… it certainly has a role to play,” said Patel, be it World Bank, IMF, or OECD.
3. German bunds
Another important factor was the jump in bond yields in developed markets, particularly the German bund, this week.
Earlier in the year, the German 10-year bund had hit an extreme low and has been on the rebound ever since. The European Central Bank had essentially been flooding the market with euros by buying up German bunds, and asset managers were investing their euros all around the world, including in emerging market assets.
But as that trend begins to reverse, and investors begin to cash out, “all this liquidity moved back into just plain cash — plain euros,” Patel said.
Lastly, as a Goldman Sachs note put it, “currency is a major culprit.”
The strong US dollar has essentially led to a depreciation of emerging market currencies. According to Patel, it’s like a negative wealth effect.
EM investors “experience a loss of capital because their currency’s now worth considerably less,” he said. “And to maintain their purchasing power, they’re being forced to sell some of the liquid assets which happen to be some of their equity and bond holdings.”
That, he says, is what we’re seeing in the flows data. And it’s not just an emerging market problem, Patel notes. As the dollar rises, all currencies have been depreciating against it. But it is especially hard on the EM currencies.
Not yet Taper Tantrum Round 2.
Patel says it’s “a little too soon” to be calling the next “taper tantrum.”
“As of this moment, the taper tantrum thing is still just one of the smaller factors — it’s not a full-blown phenomenon,” he said.
But he did admit that while recent market jitters have stemmed from technical things, there could be a negative contagion effect down the road.
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