The Taper Tantrum’s Repeat Rejection
Early year optimism that 2017’s double-digit emerging market stock, bond and currency upswings could persist was overtaken by opposite sentiment and direction toward mid-year, with all asset classes in decline amid fears of a liquidity and economic squeeze reprising the 2013 US Federal Reserve-induced taper tantrum. Industrial country central banks are now in the end game of quantitative easing which contributed to developing world portfolio inflows, but over a decade the correlation could never be precisely proven, and major emerging market monetary policies were often loose as well. Average GDP growth and inflation forecasts in the 4-5% range have been relatively constant over the past six months, and trade and geopolitical conflict risks were heightened since the onset of the Trump administration’s bellicose commercial and diplomatic stances. Renewed emerging market qualms should not revert to 5-year old explanations of external forces, including the higher dollar, that help dictate fate but instead reflect the inability to construct their own global leadership and reform narratives for the next five years.
According to fund trackers, foreign investor inflows turned to outflows in May, but net allocation was $20 billion for local and hard currency bonds, and $35 billion for core and frontier equities at end-June. Stock market earnings and valuations were steady, with the latter still at a sizable discount to advanced economy counterparts, and international sovereign and corporate issuance was on target with respective $100 billion and $200 billion-plus gross totals, and rollovers managed with recycled cash flows. Almost all currencies were down against the dollar, but with the exception of countries like Argentina and Turkey with large payment imbalances, the trend retraced previous appreciation, and central banks and securities regulators did not panic as they prepared policy and rate defenses. Argentina bolstered its backstop by turning to the International Monetary Fund for a classic standby program, with $15 billion immediately released from a $50 billion line to cover external financing needs into next year. Outright crisis was further contained with MSCI’s decision to reinstate core index status, reflecting capital market modernization under the Macri administration which stood out in the universe as a distinct “second generation” agenda.
China, in contrast as the biggest MSCI weighting, got only a short-term bump from “A” share inclusion as investors bridled at poor governance practice at both state and private company listings, amid festering trade and debt concerns that are widespread in Asia and other regions. The counter-strategy to breakup of industrial/emerging market pacts like the Trans-Pacific Partnership and NAFTA is formation of pure developing economy blocks, where progress has been slow despite stated ambitions. TPP has yet to resurrect as a bi-regional Asian-Latin American arrangement; the pan-European single market is in jeopardy with Brexit and reduction of Eastern nation cohesion aid; and even with breakthroughs like Africa’s new continental zone the details are murky under long phase-in periods. These fresh deals are more urgent in view of the flat $800 billion in foreign direct investment in 2017 the United Nations recorded in the developing world, historically a multiple and driver of the portfolio number.
Emerging market foreign exchange reserves have rebounded from a year and a half of depletion, especially in Asia and the Gulf, but external corporate debt is under a heavy repayment schedule in 2019, and private borrowing in all forms including household remains a vulnerability despite official deleveraging campaigns. Credit has continued to outpace GDP growth over the past decade, and banks have not reckoned with bad loans under an extended favorable business cycle from liquidity-fueled demand at home and abroad that may now be turning, especially without underlying productivity gains that should also be a policymaker priority. As the asset class tackles these issues on its own terms, second half results are poised to selectively improve in line with country commitment, and a second post-taper tantrum wind can banish the concept as a different future rationale dominates.