Brace for more bad weather emerging

Amid all the worry of a taper of economic stimulus in the United States last year, the most obvious hints of stress in the global economy were seen in emerging markets.

Since a May admission from US Federal Reserve chairman Ben Bernanke that a reduction to the central bank’s bond-buying program may be imminent, developing economies have been home to sporadic, though significant, falls in both stock prices and currency valuations.

Could the emerging markets, so beloved by investors for much of the past decade, hold up as a flight to the safety of the US dollar and US-denominated assets took place?

Over the past week or two we may have received an answer.

Three emerging market economies in particular – Argentina, Russia and Turkey (the ART countries, for short) – have been the subjects of remarkable devaluations of their currency.

The most violent was in the South American nation where the peso (which, to be fair, has never been a bastion of stability) fell a staggering 8 per cent in one day – and that was only after the nation’s central bank stepped in to reverse losses of as much as 15 per cent in morning trade.

A 15 per cent slump was, however, still reached over a 48-hour span.

Turkey’s lira, meanwhile, has consistently set record lows against both the US dollar and the euro over the past few months; while Russia, which is desperately trying to put on a brave front as it ‘opens’ its nation to the world for the Sochi Olympics, has seen its ruble drop to a five-year low against the US dollar and an all-time low against the euro.

In all cases there’s method to the madness. Argentina finally released the brakes on its currency manipulation, which stems from its last economic disaster. An official inflation rate of 11 per cent meant that such a move was always going to trigger a rush for the exits, and more trauma appears assured.

Russia’s economy is also flagging just as it is freeing up trade in its currency, and Turkey is beset by a political crisis as well as fears over its growth prospects.

Worryingly, the ART countries aren’t alone.

Brazil’s real fell a few per cent over the week, as did South Africa’s battered rand, India’s rupee, Mexico’s peso, Malaysia’s ringgit and Indonesia’s rupiah. All have witnessed substantial declines over the past 12 months.

As a result, a Bloomberg tracker of 20 emerging market currencies hovers at its lowest level since 2009, while global fund tracker EPFR noted last week that emerging equity and bond funds have witnessed outflows of almost $5 billion in the year to date. That adds to over $50 billion from last year.

Australia’s currency, too, has taken a hit. While it shouldn’t be grouped with the emerging economies, there is no question Australia’s high interest rates (compared to the rest of the developed world) have led to an influx of offshore investment over recent years.

Now some of that money is returning to America, and while manufacturers, the tourism sector, the Reserve Bank of Australia, the government and retailers may all be temporarily cheering, if a devaluation occurs at any faster clip, we could be in trouble. If not for the true impact on the economy, then for what a rapid devaluation signifies about where the global economy is placed.

Already it has become clear, for example, that the Australian dollar’s devaluation has stirred inflation, leaving the Reserve Bank of Australia with one hand tied behind its back should it seek to further stimulate an economy that is showing signs of weakness.

History tells us that rapid currency movements create financial instability and have the potential to shake the confidence of both investors and business. The flow-on effect can see the kind of flight to safety we witnessed during the financial crisis, which makes last week’s fall in US Treasury yields particularly concerning.

In 2013, yields climbed more than one per cent as optimism grew about the US economy, encouraging investors to exit their emerging market holdings and move them back to the US.

But with yields sinking over recent weeks, along with emerging market stock markets and currencies, it suggests the exodus has not been related to either a hunt for yield or confidence in the US economy, but rather a flight to safety.

It all serves as a chilling reminder that we remain in uncharted waters, leaving any exit push as a daunting event for a market desperate for its next fix.

Daniel Palmer is Business Spectator's North America correspondent @Danielbpalmer