March 12, 2015

The violent acceleration over the last week of what was a steady sell-off in emerging market currencies evokes ugly echos of the taper tantrum of 2013.

Then, as now, fear of the US Federal Reserve has sent investors scrambling to cut their EM exposures.

When viewed over a three-month period (see first chart), the two sell-offs against the dollar are pretty similar in size. Hungary, Poland and Romania are the notable exceptions this time round, with the weak eurozone economy dragging them down.

And if one excludes Thursday’s bounce, the acceleration in March has been quicker than the first few days of the taper tantrum in May, 2013. (See the second chart).

However, beneath the similarities in scale, analysts and economists point to bigger differences.

The taper tantrum — triggered in May 2013 when then Fed chairman Ben Bernanke signalled the central bank would start tapering its quantitative easing programme — catapulted Treasury yields higher and those on EM lurched upward too.

As Geoff Dennis, head of global emerging market strategy at UBS, argues, Mr Bernanke caused a sell-off across all EM assets — currencies, bonds, equities — while the current squeeze is concentrated in EM currencies. Mr Dennis says:

The taper tantrum was a much more of a bond move, with EM assets reacting to the sharp rise in US Treasury yields.

However, what we are seeing this time around is the result of a broader US dollar rally. All major currencies, notably the euro, have fallen against the US dollar. The current sell-off is not exclusive to EMs.

And data from fund tracker EPFR underscores the taper tantrum’s bigger breadth.

While investors pulled more than $53.8bn out of emerging market equity and bond funds between May and September 2013, outflows from these funds for the year to March 6, at $5.4bn, are much more subdued. More interestingly, much of that outflow was in January.

This time around EM bond yields have remained relatively stable. The average blended yields on JPMorgan’s benchmark EMBI Global Diversified index of sovereign and corporate bonds for emerging markets currently sits at 6.23 per cent, compared to 6.15 per cent at the start of the year.

That’s a sharp contrast to the 1.67 percentage point spike in EM bond yields between May 22 and early September, when the Fed pulled back from tapering.

Benoit Anne, head of emerging markets strategy at Société Générale in London, says:

The big difference between now and 2013 is that in 2013, there was a huge run-up in emerging markets assets.

Indeed, EM assets were enjoying an unprecedented bull run in the 12 months prior to May 2013.

Ultra-loose monetary policy in the US and Japan kept yields on assets in developed economies low and range-bound, prompting investors to seek higher returns in EM and frontier markets. Mr Anne says:

Everyone was long on EMs, including investors who don’t normally invest in EMs.

So investors were caught by surprise by Bernanke’s tapering comment. And what you saw in 2013 was the flood of hot money that was going into EM suddenly rushing back out. It was pure panic.

Nearly two years on and the valuations look very different.

EM positions are very light now, said Mr Anne. Everyone is now mega long on the dollar and short on EM currencies.

What’s more, although the Fed is creeping towards lifting its overnight lending rate for the first time since the financial crisis, US government bond yields are well anchored as inflation remain subdued and yields on Eurozone debt are even lower.

Growing confidence in the US economy has instead been expressed through the dollar which has jumped 10 per cent this year.

Although the mood towards EM currencies is expected to stay sour in the medium turn, analysts say the lower valuations of EM assets means there’s a smaller risk the sell-off will degenerate into a freefall.

What we will probably see is a series of mini-rallies and mini-corrections, said Mr Anne.

Nor has this sell-off been as indiscriminate as 2013.

The collapse in crude prices, for example, has rattled the economies of major oil producing EM countries like Brazil and Russia, but importers like India are reaping the benefit of falling inflation.

The rupee crumbled 22 per cent between May and September 2013, but is little changed against the dollar this year.

David Rees, an emerging market economist at Capital Economics, says:

In terms of policymaking, the situation is perhaps less troubling this time.

Inflation is generally lower following falls in food and energy CPI. Therefore, weak exchange rates unlikely to cause inflation to become uncomfortably high and force rate hikes. Few countries have balance of payments concerns too. Most likely to be affected in these two ways are Brazil, Turkey and South Africa. The Fragile Five may have been whittled down to three.

Source for charts: Capital Economics