By Maleeha Bengali
The Argentinian Peso plunged 12% yesterday as it touched 41 pesos to the U.S. dollar. This is despite the central bank raising rates to 60% in an attempt to halt the currency and stem the rapid rise of inflation. The currency collapsed a day after the country asked the IMF for an early release of a $50 billion bailout loan, already agreed by the bank. In return for the IMF's support, the country has agreed to reduce its deficit to 2.7% this year from 3.9% in 2017. However this has not helped it in any way and the peso is down 45% vs. the USD year to date.
Emerging markets yesterday were further rattled by the falling Turkish lira, plus the Indian rupee falling to a new record low against the dollar -- the latter now down 11% since the start of the year. But the rest of Emerging Asia has been resilient. Despite sensationalist media reports, rather than blanket sell all EM currencies, the market has been making a distinction. These countries have been struggling with rising USD rates due to the deficit in their fiscal and current account balances. At times of low USD rates, they borrowed cheap dollar debt and used it to expand their countries, essentially overspending. Now due to trade tariffs and the dollar's rapid rise, they are witnessing capital outflows, which is sort of self fulfilling, as the countries with the highest debt are affected the worst.
Morgan Stanley released a report recently that showed each country's external financing needs defined as the external coverage ratio. It is calculated be dividing a country's reserves by its 12-month external funding needs, which in turn are the sum of i) the current account, ii) short-term external debt and iii) the next 12 months' amortizations from long-term external debt. Countries at the bottom end of the chart are -- not surprisingly -- Turkey, Ukraine and Argentina, which have external coverage ratios of < 0.5 and so on. As the USD rises, the market is clobbering currencies most exposed (left side of the chart) moving up along the right -- in a domino effect.
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There is a lot of debate about the contagion effect of these currencies into broader Asia or even developed markets. But the issues are rather idiosyncratic due to the excess spending and domestic issues prevalent in these regions over a long time. Some of these countries have always been the poster child for IMF bailout packages.
On the issue of broader contagion, what happens with Chinese yuan and Chinese deleveraging is more of an issue with respect to world economic growth prospects than the collapse in select EM currencies.
Last night, President Trump addressed more than 10 topics as part of this wide ranging Bloomberg interview. The market was severely confused as it tried to skim through the headlines to get a clue which sector would be the next casualty. He covered everything from cutting capital gains tax, Fed Chair Jerome Powell, Attorney General Jeff Sessions, Trump's desire to withdraw from the WTO, Trump's rejections of the EU offer to cut auto tariffs and the trade deal with China, to stating Google (GOOGL) and Facebook (FB) were in a "very anti-trust situation." Other than his dire need to randomly blurt whatever topic of the day bothers him, and his prose limited to using simple adverbs twice for emphasis, what does it all mean?
About $200 billion worth of tariffs on Chinese goods goes into effect next week, and the market is a bit worried about what Trump's next move is here.
The yuan needs to be monitored. It has been stable at 6.80 to the USD for the past few weeks, since China first mentioned policy measures to support the currency. The USD has been weakening over the last two weeks, and holding firm above 1.165 EUR/USD. Fed Chair Powell's speech from last week indicated that inflation was not overheating, which is taking the probability of a USD rate hike in December down. The JPM August NBS Manufacturing PMI report showed modest improvement, and some current activity indicators show a small improvement in Chines domestic activity, so investors are perhaps too pessimistic on the Chinese growth story and its implications for demand of raw materials.
Copper has been holding above $6000/tonne. As we move past the official labour day holiday this Monday -- and investors return to their desks to see such wide discrepancies between US and emerging markets of between 20%-40% -- I am sure all the analysts will be put to work to run their models and spit out price/nav valuations.
Keep an eye on the USD, as it is the key to everything. Especially for commodities and China-related stocks.