The Fate of Emerging Market Currencies Hangs in the Balance!
Emerging market currencies are feeling increasing pressure ahead of the upcoming two Fed meetings. An interest-rate hike would most certainly send EM currencies to their nadir.
EM Stocks Rally but EM Currencies Dip
The fate of emerging market economies is uncertain at best and dismal at worst. Emerging markets have a proclivity to contract when central banks in developed economies raise interest rates, or alternatively when the currencies of developed economies are strong. We have seen a sustained period of dollar strength coupled with EM currency weakness. This relationship is based on a multitude of factors which have synergistically combined to drive EM currencies further into the red. For starters, we have endured the worst performance to date on the Shanghai Composite index and the Shenzhen Index. That trillions of dollars were erased from equities markets has deeply impacted on emerging market economies around the world. Brazil, Russia, India, South Africa, Venezuela, Zambia and scores of other countries are reeling from the China meltdown.
Weak Demand and Oversupply Crushes Markets
What happened is all too familiar to market participants. We have witnessed a sharp reduction in global commodities demand spurred by weakness in the world's second-largest economy - China. This in turn has resulted in decreased profitability, mass layoffs and the shuttering of mines. Even countries like Australia which are first world economies are suffering as a result of mining sector weakness. Low commodities prices mean that EM countries which rely on mining and agricultural production are now suffering. Worse yet is the capital flight taking place from EM countries to developed countries where the stability of the financial markets is preferred. It is the volatility of emerging market economies that acts as a deterrent to capital investment, and accelerates capital flight from those nations. In fact, all BRICS countries have suffered massive capital flight this year, and this trend is set to continue.
EM Currency Slide Continues
We have recently seen stocks from emerging market economies gaining ground, while the currencies of these countries continue to slide. The reason being: commodity prices are low and companies operating in emerging market economies are suffering as a result. The MSCI emerging markets stock index gained 0.6% to hit a 3-week high, buoyed by Asian stocks. Much the same was true across Eastern European markets and Central European markets. While the South African Rand recently managed to claw its way back for a 2-day rally, it slipped once again, as did the Turkish lira and the Russian ruble. We can expect more of the same to continue as the October 27-28 deadline approaches for the next Fed meeting. While most analysts agree that the Fed will be unlikely to raise rates at that meeting, a December rate hike is not out of the question. When the Fed raises rates, the Bank of England is likely to follow soon thereafter. This will make currencies like the USD and the GBP far more attractive to international investors, causing a selloff of EM currencies and a rush to purchase dollars and pounds.
Can Glencore's Actions Save EM Economies?
We saw the Glencore PLC debacle playing out on markets and this is likely to reverberate far and wide with rival mining companies. Clean call announced the shuttering of 2 of its mines in Africa - one in Zambia and one in the Democratic Republic of Congo. These mines are responsible for 2% of global copper production. Glencore is seeking to reduce copper output, thereby bringing about equilibrium in the markets, and running down inventories levels so that mines can become profitable once again. Rival companies are being challenged to do the same, and should this prove true, it will ultimately bode well for the long-term success and profitability of mining companies operating in emerging market economies. Glencore is the worst performing major multinational conglomerate on the FTSE 100 index for the year, but the stock recently rallied to over 106.15 pence a share on the back of talk of a takeover or privatization. Both of these rumours have since been dispelled.