Yes, it’s August, but the image that came to mind in some corners of the financial markets this week is of a snowball rolling down a hill – gaining speed and size.  A couple of Asian countries – India and Indonesia – set that tone this week with some eye-popping numbers.

  • The stock market in Indonesia has lost 20% of its value since May, with half of that loss coming since mid-August.  The Indonesian currency – the rupiah – has lost 11% of its value since May, again with half of that loss coming in the last couple of weeks.
  • India’s currency – the rupee – lost 18% since May, with almost 6% of that loss coming in the last week and a half.  The Indian currency is at its all-time lows against the dollar, trading at levels this week of around 65-66 rupees per U.S. dollar. 
  • Later in the week, we saw the selloff spread to the currencies of Turkey, Thailand and Malaysia.

The core problem for emerging markets is one that we have mentioned before, and this timing is not an accident.  The hemorrhaging of foreign investment from emerging market countries is a direct result of market expectations that the U.S. Fed will begin tapering asset purchases. The resulting rise in bond yields has given investors another (somewhat safer) alternative to emerging market assets.  That trend has only accelerated in the last couple of weeks.

What is interesting though is that this bleeding is spreading in a particular pattern. The worst of the declines are hitting countries with large current account deficits – essentially those that import more than they export.  That reliance on outside funding to continue those imports makes those countries and their currencies vulnerable.

This does beg the question of what can these countries do about it – and the answer is, not much.  The traditional measure of central bank intervention to buy local currency is limited to the amount of foreign reserves, which can quickly run out.  Raising local interest rates to attract foreign investment risks squelching the local economy at an already precarious time.

My View:  This trend will, unfortunately, continue.  Like most market trends, it will also overshoot its true equilibrium and snap back.  But for now, the snowball will continue to gain speed.

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