Mark Adomanis in Philadelphia -
The years between 2002 and 2008 were a really good time to bet against the US dollar. Compared with a broad basket of foreign currencies (including currencies from the Eurozone, Canda, Japan, China, Mexico, the UK, Russia, Brazil, and India), the dollar shed almost 30% of its value.
In the aftermath of the Lehman Brothers bankruptcy, the dollar temporarily rallied, but it soon started to shed its value again, bottoming out in the late summer of 2011 at a level 6% below where it had been all the way back in 1997. Quite a lot of emerging market enthusiasts proclaimed the dollar’s coming demise as the world reserve currency.
From a certain standpoint, the dollar should have continued to fall or at the very least stayed stable. The US accounts for a shrinking percentage of total world population and total world economic output. Given those two basic and inescapable facts, you wouldn’t expect the dollar to surge in value. But surge it has. In early August the dollar was, on a trade-weighted basis, the strongest it has been in more than a decade.
2015 has truly been the annus horribilis for emerging market currencies. The headlines can read like dispatches from a war zone: the Russian ruble is getting “crushed”, the Turkish lira “battered”, the Brazilian real “losing ground rapidly”. China’s recent decision to devalue the yuan hasn’t yet been fully digested by the markets, but it is almost universally acknowledged as something that will put further pressure on a broad range of emerging market currencies.
2014 saw a few particular currencies like the Ukrainian hryvnia and Russian ruble nosedive, but the carnage in 2015 has been impressively broad in scope: India, Russia, Turkey, Brazil, South Korea, and Taiwan have all seen their currencies weaken noticeably.
Given the scope of emerging market forex losses, it certainly seems less like a considered response in reaction to particular sins (countries with large current account surpluses and deficits have been losing ground at similar paces) and far more like a comprehensive change in investor sentiment. The question is how long this change in sentiment will last – and there are reasons to think that it will last quite a while.
Fed Rate Hike
Another factor weighing heavily on emerging market currencies is the likelihood of a looming hike in the Federal Funds rate. The estimates can be less than precise, but futures contracts currently suggest that investors see a roughly 45% probability of a 25-basis-point increase in interest rates at the Federal Reserve's September 17 policy meeting.
The recent selloff in commodities (particularly oil) and the attendant disinflationary pressure has led some analysts to suggest that the Fed will not actually make any moves at its September meeting. Certainly, a rational argument can be made that a September hike would do more harm than good. But even if the Fed waits until December to raise rates, one thing does seem clear: in the short and medium term, US interest rates are heading higher, while emerging market rates are heading lower.
That is a fundamental fact that will exert even greater pressure on emerging market currencies if not in September, then at some other point in the near future
Much of the current apprehension on the part of emerging market investors has to do with politics. Brazil is currently going through one of the most serious political crises since it returned to democracy. Turkey is similarly going through a dramatic political crisis, with open accusations that President Recep Tayyip Erdogan is stoking a war in the hope of boosting his poll numbers. Russia is among other emerging markets with escalating and intractable political problems that are unlikely to be resolved in the short term.
Truth be told, very few of these political problems are of recent vintage, but investors’ appetite for political risk appears to have shrunk considerably. And these sentiments usually prove to be quite “sticky”: changing them takes a while, but once they start to move in a particular direction they keep doing so.
In the short term, things seem likely to get a whole lot worse before they get better. According to former IMF economist Stephen Jen, China’s recent devaluation could send emerging market currencies plunging by a further 30-50% over the next nine months. The recent swoon in oil is likely to even more severely impact major producers like Mexico, Russia, Saudi Arabia, and Columbia.
But from a much longer-term perspective it’s hard to see how these recent trends can be sustained. As noted previously, the US accounts for a gradually shrinking percentage of total economic activity. I’ve never seen a forecast from the IMF, the World Bank or the OECD that has the US growing above the global average for any length of time. It’s hard to see, logically, how the dollar can sustain its current position given that reality. From a demographic and economic perspective, the future clearly lies in the emerging markets in general, and Africa in particular.
Emerging market bulls might have the right strategic interpretation, but they are in for a rough ride over the next few years.
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