Emerging Markets

With commodity prices dropping, slowing growth expectations, and fickle foreign capital, emerging economies braced for market volatility and capital flight. Countries with the largest current account deficits saw dramatic currency depreciation (Turkey, South Africa, Brazil, India, and Indonesia). However, after central bankers reassured markets, emerging market investors returned. Though markets eventually returned to normal, volatility whipsawed many emerging market traders.

This market whipsaw is shown in the plot on the right. Emerging markets were strongly impacted in the quarter with a significant reduction in emerging market index prices relative to the advanced economy index prices. Central bank reassurance then initiated a market rebound.

The plot to the right shows the normalized index values plotted for MSCI benchmark indices for advanced and emerging markets (URTH, EEM). The divergence and later convergence between advanced and emerging indices suggests that large institutional investors exited and later returned to emerging markets. Based on past monetary flow analyses, it is often the case that monetary flows pull back from emerging economies faster than advanced economies because investors have less confidence in emerging market banks, counterparty reliability, corporate solvency, and legal system fidelity.

Slow growth and market uncertainty also created a pronounced Chinese liquidity squeeze in June that caused major increases in repo rates ranging from 2-30% during the quarter. At the extreme, interbank lending was reduced by 60% and large intraday fluctuations in seven day repo rates (2,329 basis points at the extreme on June 20th). Like most other central banks, the People’s Bank of China (PBoC) intervened to regulate interbank liquidity/volatility and stabilize markets.

With no definitive central bank withdrawal in sight, volatile market developments triggered by central bank whispers are the new normal.

Source: The Bank for International Settlements

         

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