Emerging Markets Feel the Ripples of Fed Tapering

Wardwell’s Weekly Market Report
Observations on the Capital Markets – Week Ended August 23, 2013

  • Emerging markets/Asian currencies see sell-off
  • Software glitches caused two trading mishaps in one week
  • In the U.S.: FOMC minutes suggest some agreement. Economic data upbeat
  • Europe watch: upbeat economic data, Germans talk about Greece
  • China saw upbeat economic data; Japan pledged “whatever it takes”

Emerging Markets/Asian Currencies See Sell-off
Many Emerging Market currencies (notably those of India, Brazil and Indonesia) have been weak since the beginning of May. The declines accelerated sharply in recent weeks, leading to something approaching panic in several markets last week.

Much of the sell-off is probably due to the (increasingly panicky) retreat of “hot” money that moved into these currencies seeking yield when the Fed pushed U.S. rates down—emerging market bond mutual funds have seen large redemptions. A second possible culprit/contributor is weakening fundamentals, as slowing growth in China ripples through the commodity-export-oriented economies of ASEAN countries.

The Chinese currency is a notable exception to the pattern of currency weakness: it has risen modestly but steadily against the dollar in the past 4 months. I noted last week that China’s been selling Treasuries—which would support its currency—but that doesn’t seem to be why its currency isn’t falling…rather, its currency hadn’t appreciated as much in the “hot money EM currency rally”…so there’s been a “re-alignment” trade within Asia.

Comment: This feels more like a panic to me (too late to sell…maybe time to start buying?) rather than the start of another Asian currency crisis. Fundamentals and currency valuations don’t seem as imbalanced now as they were in 1997…and the fall in ASEAN currencies relative to the Chinese renminbi should help the ASEAN countries recover.

Software Glitches Caused Two Trading Mishaps in One Week

Goldman Sachs Dodged a (self-aimed and fired) Bullet – Goldman roiled options markets last Tuesday when it executed thousands of options trades at bad (for Goldman) prices. The firm blamed a software glitch, and in the end most of those trades were voided, saving Goldman big bucks…and potentially imposing comparable losses on those who traded with Goldman, since other trades those counterparties made (to book profits and/or rebalance exposures) won’t be broken.

Comment: While the decision to break the trades was justified by “fine print” in the exchanges about “obviously wrong” prices, there’s a huge “moral hazard” problem…and a fiscally mortal hazard for counterparties. The firm that made the error got off the hook while those who bought on weakness were saddled with losses and/or unbalanced books. Further, it doesn’t help the markets function.

NASDAQ Froze . . . and the World Kept Turning – A software glitch shut down NASDAQ for 3 hours on Thursday. There was no material impact in the real world of producing and consuming goods and services.

In the U.S.: FOMC Minutes Suggest Some Agreement. Economic Data Upbeat.
Federal Open Market Committee (FOMC) minutes supported the view that QE will end mid-2014, but shed no light on September.

  • “Almost all” agreed not to reduce QE in July and confirmed that they were (data-dependent, of course) comfortable with moderating the pace of QE later this year, tapering to zero around the middle of 2014. The next FOMC meeting will happen on September 17-18.

Meanwhile, last week’s economic and housing data were relatively upbeat.

  • Initial unemployment claims ticked up to 336k, but the four-week average fell to a new cycle low. The Index of Leading Economic Indicators rose 0.6%; other leading activity/manufacturing indicators – The Chicago Fed National Activity Index, The Kansas City Fed Manufacturing Index, Markit’s US – were up as well.
  • Existing home sales were up 6.5% month over month (m/m) in July and 17% year over year (y/y), much higher than expected, and the highest level in almost four years. The median home price was up 14% y/y, in no small part because foreclosures and short sales fell from 24% of sales a year ago to 15% this year. Purchase mortgage applications ticked up as well.
  • On the other hand, new home sales volumes fell sharply and refinancing applications continued to fall.

Comment: The expectation of rising rates has been boosting demand in the short run—pulling future demand into the present as buyers rush to lock in rates—but demand will fade after this rush. Higher rates will also be a drag, but affordability remains good even at current mortgage rates.

Europe Saw Upbeat Economic Data, Germans Talked about Greece

  • The Markit EZ flash PMI rose from 50.5 to 51.7 in August (its largest increase in more than 2 years).
  • German Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble said in separate newspaper interviews that Greece won’t get another haircut on debt. Later, however, Schaeuble admitted, “There will have to be another program for Greece.” and suggested that interest rates on EZ loans to Greece might be lowered.

China Saw Upbeat Economic Data; Japan Pledged “Whatever it Takes”

  • The HSBC Flash China Manufacturing Purchasing Managers’ Index rose from 47.7 to 50.1 in August, its first increase in 5 months and its first 50+ reading in 4 months. The new orders sub-index rose to 50.5, also a four-month high. The Conference Board China Leading Economic Index (LEI) also increased.
  • Bank of Japan Governor Kuroda said “If the economy does not recover and prices do not rise compared to our commitment to achieve 2% inflation in two years and revitalize the economy, monetary policy will be adjusted.” Kuroda and Finance Minister Aso agreed the economy is strong enough to withstand the scheduled sales tax hike.
  • Separately, rising energy imports drove Japan’s monthly trade deficit to its third-highest level ever despite a double-digit y/y increase in exports.

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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