Emerging markets fear tapering talk
Speculation that the United States Federal Reserve may begin tapering next month, perhaps reducing bond buying by $10-billion in September, has seen emerging markets and currencies tumbling around the globe, from the rand and Indian rupee to the Thai baht and Brazilian real.
With the Fed chairperson Ben Bernanke’s term coming to a close in January 2014, markets are reacting strongly to the possible winding up of quantitative easing never undertaken on this scale before.
Emerging market shares are showing significant losses. During the past week, the iShares MSCI emerging market index has showed a steady downwards fall, dropping by 5% in the course of a week to $38.36 on Wednesday.
The index also saw its share of volatility: a high of $40.22 in the last week of July had dropped to $38.54 at the end of the first week of August. It rose to $40.17 over the next seven days and then plummeted again to its current rate.
Along with this, Chinese growth data is a shadow of its former double-digit self, with analysts predicting growth of about 7.5%, spelling difficulties for economies reliant on exports to the Eastern giant and promising increased volatility.
The South African market faces unique domestic challenges, including possible strikes in the mining sector and work stoppages in the automotive industry.
Resource stocks also underperforming
Resource stocks, too, have been underperforming — BHP Billiton this week reported attributable profit decreased from $7.18-billion to $6.12-billion, well below analysts’ expectations, and the commodities giant Glencore Xtrata posted an $8.9-billion loss.
July’s inflation data brought more bad news, at 6.3% outstripping consumer price index predictions.
There is little comfort that, in the grand scheme of things, South Africa is not alone.
The rand dropped to a six-week low early in the week at an exchange rate of 10.227 to the dollar. By lunchtime on Wednesday, it had slid to R10.238.
Emerging market currencies are “starting to be punished more heavily for running interest rates that are too low and current account deficits that remain too wide,” Tradition Analytics wrote.
“South Africa shares this status and there is reason for continued underperformance of the rand as strike action intensifies.”
Yields on South African bonds also climbed, with Reuters reporting they hit their highest mark in the past 19 months at 8.67% for the 2026 benchmark bond on August 20.
Similarly, 10-year bonds were selling at 8.29% on Wednesday. But these signs were an indication of a global sell-off of emerging-market shares rather than a situation unique to South Africa.
Investors to buy on lows
According to Kenneth Rapoza, emerging markets contributor for Forbes, investors will buy on the lows. But, he said, this is a market ripe for deeper corrections.
“Risky assets continue to be weighed down by rising rates in the US. Ten-year [US] treasury bonds are now yielding 2.83%,” Rapoza said, adding that European equities had followed the downbeat tone in Asian markets and that high-yielding emerging currencies are bearing the brunt of it. “And it’s not over yet,” he said.
The underperformance is likely to continue as the starting point of the Fed’s tapering draws nearer.
An editorial in the July 27 edition of the Economist explained it this way: “When a champion sprinter falls short of his best speeds, it takes a while to determine whether he is temporarily on poor form or has permanently lost his edge. The same is true with emerging markets, the world economy’s 21st-century sprinters,” it said.
“After a decade of surging growth, in which they led a global boom and then helped pull the world economy forwards in the face of the financial crisis, the emerging giants have slowed sharply.”
The slowdown marks what the publication refers to as “the end of the dramatic first phase of the emerging-market era”, one that saw those economies jump from 38% of world output to 50% (measured at purchasing-power parity) over the past 10 years. Its prediction was unequivocal: “Over the next 10 years, emerging economies will still rise, but more gradually.”
It's not the end
However, according to Peter Attard Montalto, executive director and emerging markets analyst of Nomura International, the advent of the much-speculated tapering will not mark the end of an epoch.
“We certainly wouldn’t say it’s the end of an era. Quantitative easing has accelerated a long-term trend of increased asset allocations into emerging markets and that is not going to reverse.”
Nevertheless, he said, those who continue to buy into emerging markets will become much more selective. “New flows will stall and will become much more picky over credits. This is where South Africa will suffer with higher funding costs.
“Under such an environment [where] the proverbial tide has gone out, problems will be exposed, like in China,” Attard Montalto said.
In light of this, investors will become more critical of the investment risks posed by the country.
“Unfortunately, South Africa does badly on a number of fronts. Markets view it as a bad credit, it has a huge need for foreigner funding through the [current account] and also it has one of the highest exposures to the China slowdown by our analysis,” said Attard Montalto.
Market recation to tapering
He did not envisage a “capital flight or crisis type scenario for South Africa”, but a number of factors needed to align for the country to continue to attract foreign capital.
Still, said Attard Montalto, the market reaction to tapering was somewhat overdone, a sentiment echoed by American financial expert, John Mauldin.
“The assumption is that all the juice in the economy is somehow the product of the Federal Reserve’s actions,” Mauldin wrote in a newsletter this week. The explanation was overly simplistic.
“I’m pretty well convinced that there is something more fundamental going on. And that even bigger changes may be coming in the near future,” he said.
Several research papers and articles have contested the overall efficacy of quantitative easing, meaning that tapering may not be the fundamental game changer in shifting economic norms.
One, released by the San Francisco Federal Reserve, is titled “How stimulatory are large-scale asset purchases?”
Its authors state: “The Federal Reserve’s large-scale purchases of long-term treasury securities most likely provided a moderate boost to economic growth and inflation. Importantly, the effects appear to depend greatly on the Fed’s guidance that short-term interest rates would remain low for an extended period. Indeed, estimates from a macroeconomic model suggest that such interest rate forward guidance probably has greater effects than signals about the amount of assets purchased.”
According to Mauldin, what the authors are actually saying is that the latest round of quantitative easing, massive as it has been, has not had all that much effect on the economy and that the far more important question concerns the level of interest rates.
Mauldin says consensus predictions are that low interest rates will prevail in the US for a “very long period of time”. “Indeed,” he said, “it is that low-rate regime that we should be paying far more attention to than to tapering.”
What the latest CPI figures mean for SA
The consumer price index figures for July, released by Statistics South Africa, accelerated to 6.3% year on year, marking an increase on the previous month’s figure of 5.5%. They are expected to fuel union wage demands, adding to the volatility of the market.
About 30 000 workers at several of the nation’s automotive manufacturers, including Toyota, Ford, General Motors, Volkswagen, Mercedes-Benz and BMW, downed tools on Monday demanding increased wages and improved working conditions. It is estimated the strike is costing the economy about R600-million a day in lost production.
The mining industry is being plagued by threats of unrest over an ongoing stalemate between unions and gold producers, with the Chamber of Mines’ offer of a 5.5% increase being rejected.
The inflation hike is yet another flag that workers’ disposable income is coming under increasing stress.
“Upward price pressures stemming from petrol, electricity and other utility costs are eroding disposable income at a time when unemployment is rising and income growth is sluggish,” said Investec group economist Annabel Bishop.
“Consumers that are already heavily indebted are struggling to take on further debt to supplement incomes as credit providers tighten lending standards.”
Nomura emerging markets economist Peter Attard Montalto said external factors meant inflation levels were unlikely to abate. “During this period, we think core inflation will continue to rise with [the US dollar to rand exchange] rate stuck at 10 and a difficult wage round this year filtering through,” he said.
Will the Fed be headed by an economist who was ‘fired’ from Harvard?
Speculation is rife about who will succeed the United States’s economic golden boy and chairperson of the world’s biggest central bank, Ben Bernanke, when his term comes to an end in January.
With less than five months to go, two candidates are seen as serious contenders: Janet Yellen, the vice-chair of the board of governors of the US Federal Reserve Bank, and former US treasury secretary Lawrence Summers.
Both have impressive résumés and are considered academic heavyweights. Yellen was previously the president of the Federal Reserve Bank of San Francisco.
Summers has never occupied a central bank role, but was treasury secretary in the Bill Clinton administration from 1999 to 2001 and headed the White House’s National Economic Council in 2009 and 2010.
Academically speaking, Summers may be the frontrunner. Whereas Yellen has published fairly prolifically, often collaborating with her husband, George Akerlof, who won the Nobel Prize for economics in 2001, Summers is rated as among the top 5% of economic authors.
Indeed, he was even president at Boston’s prestigious Harvard University from 2001 to 2006. However, it was there that his reputation took a severe knock and he resigned following a vote of no confidence by the Harvard faculty.
Although the reasons were never officially explained, it is rumoured that Summers’ defence of fellow faculty member Andrei Shleifer had something to do with it. Shleifer was appointed by the US government to help Russia to develop its fledgling capitalist system in the mid-1990s.
He was subsequently held liable for damages relating to fraud, apparent self-dealing and flouting conflict-of-interest laws, but remained an employee at the university.
Summers also provoked outrage by publicly stating that women were underrepresented in the sciences because of a “different availability of aptitude at the high end”.
By way of explanation, he suggested that the academic abilities of men fell over a greater spectrum in both the high and low ends of the scale. Predictably, his comments were not popular with the female members of the university body.