Just when you thought the world was getting to be a calmer place, emerging markets (EM) have returned to the financial headlines. Yes, we did not even get out of January before some crisis hit the global financial system again.
Starting at the end of last week, we saw massive sell-offs in the currencies of Turkey, Argentina and other EM markets. Turkey responded mid-week with a massive increase in its interest rates to attract capital back into the country. South Africa surprised markets by following suit, with an increase of smaller magnitude. However, all the efforts were arguably futile, as those currencies dropped back to pre-fireworks levels.
The reasons behind the move are simple:
- Investments flowed freely to EM countries when the Fed forced interest rates down in the U.S. The Fed's reversal of those efforts is bringing that money back to the U.S.
- Many EM countries were providing raw materials to China for production. As China slows, there is less demand for those commodities.
- During the good times of capital inflow, some EM countries failed to use that time to restructure key sectors of their economic systems.
The real question is what happens now, and far this damage will go. We will most likely see a shakeout of all EM assets and a resetting of valuation expectations in markets. There will be some pressure on U.S. assets, as the world has suddenly taken on a new sense of uncertainty.
For those with a global framework in their investments or business, it is important to keep in mind that markets are punishing all EM countries right now, but those that are in better shape will be the first to rebound. A good example of that is Mexico, which is undergoing significant positive economic reforms. Mexico is also poised to benefit from China's slowdown as a major manufacturing base.
My view: This is NOT the beginning of a major global financial crisis. There will definitely be some losers in this adjustment, but the interlinking that used to lead to massive global financial contagion has been diminished considerably. There will, however, be some short term pain. Just ride it out.
|This report is for general information and education only and was compiled from data and sources believed to be reliable. City National Bank does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors as of the date of the report with no obligation to update or notify of inaccuracy or change. This report is not a recommendation or an offer or solicitation to buy or sell any financial instrument discussed. It is not specific investment advice. Financial instruments discussed may not be suitable for the reader. Readers must make an independent investment decisions based on their own investment objectives and financial situations. Prices and financial instruments discussed are subject to change without notice. Instruments denominated in a foreign currency are subject to exchange rate and other risks. The Bank (and its clients or associated persons) may engage in transactions inconsistent with this report and may buy from or sell to clients or others the financial instruments discussed on a principal basis. Past performance is not an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.|