After an already difficult start for emerging markets (EM) this year, the situation became even more challenging this week as weak Chinese data created fresh concerns of a hard landing with a negative spill-over to other EM. The Chinese disappointment added to other headwinds for EM assets, stemming from Fed tapering and high political uncertainty in countries such as Turkey, Thailand and Ukraine. In addition, yesterday, Argentina allowed the peso to drop 13%, which fuelled speculation that the country is running out of foreign reserves (see Flash Comment EM: Storm turns into hurricane – EM sell-off escalates, 23 January 2014).
Apart from Argentina, especially the Turkish lira and South African rand have taken a big hit while India and Indonesia have so far remained relatively calm. In the case of India, an improvement in fundamentals (current account deficit is almost gone) and more signs of reforms are supportive factors. This week, a committee of the Reserve Bank of India recommended the introduction of an inflation target – something that would make Indian monetary policy much more transparent – see FT.
The renewed EM wobble comes at a time when many risk markets are technically in overbought territory and hence vulnerable to correction. European stocks went into ‘overbought’ territory a week ago, following the strong rally from mid-December. Peripheral bond markets have also looked stretched on a short-term horizon after a very strong performance since the beginning of the year.
The combination of stretched risk assets and few supportive factors for EM in the short term warrants heightened caution in risk markets. We could very well see a further correction in risk assets as investors take some profit due to the heightened uncertainty. For EM assets, the main supporting factor is that valuation looks more attractive in many markets. However, with such low visibility, investors will be reluctant to go back into EM and there is a risk that the turmoil will continue for some time as was the case several times last year.
We do not believe the turmoil in EM is big enough to threaten the global recovery. We expect the Chinese economy to get support from stronger exports this year and growth should stabilise. Inflation is also low, giving authorities the ability to support growth if necessary. EM growth in general should get support from rising western consumption growth, which has picked up steam recently across most countries (see charts).
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