It’s hard to avoid the topic of how the emerging market funds have been absolutely hammered in the last month over the premature fear of interest rates starting to creep higher in the United States.
The sophistication and liquidity in these country’s financial markets, despite their economies still being in an emerging market stage, has allowed currencies like the South African Rand to fall by 16 percent against the US dollar so far this year. Other currencies like the Brazilian Real or the Turkish Lira are down 3.7 and 4.6 percent respectively, and it’s all based upon the notion that interest rates are going to move higher in the US. This has investors scrambling for yield back to North America where the prospects of a stronger US dollar not only hurt the emerging market currencies, but also take investment away from their individual economies.
Like commodities, shares of small capitalized firms, and sovereign and corporate bonds, the emerging markets have been beneficiaries of this sustained period of record low rates. JPMorgan estimates corporate external debt from these countries has more than tripled since the onset of the 2008 crises. Not only the direct influence of investors searching for a returns outside of their normal investment arenas, but as well the idea that developed economies have plateaued in their economic advancement, and relatively greater opportunities could be found elsewhere in the world. As PIMCO’s Bill Gross points out, “investors [have] to take increasing amounts of risk, but for lower yields and more volatile returns.” First it was the BRIC’s (Brazil, Russia, India, China) and then the CIVETS (Columbia, Indonesia, Vietnam, Egypt, Turkey, South Africa) that have required investors to be more and more creative to determine where to put their money.
At the center of this is US Fed policy, and that’s where markets will continue to focus upon once again next week. This will be Bernanke’s attempt to calm markets in his team’s policy announcement and the press conference following, on Wednesday. The issue is that the last time Bernanke spoke (which was before Congress’s joint Economic Committee) was that he roiled stock markets and sent bond yields higher. During his testimony, when addressing tapering back on the Fed’s current asset purchases from 85 billion in accordance with the economy improving, the market misunderstood Bernanke and took this as the Fed will start raising rates. Investors seemed to have forgotten that not only has the Fed pledged seeing the unemployment rate fall to 6.5 percent, but also that they have attempted to end the process of quantitative easing three times in the past and failed. Bernanke has assured us he is not going to make the same mistakes as the US Fed did during the Great Depression.
It’s my impression that he is going to attempt to calm markets and in turn force down yields once again. Too many investors have falsely anticipated what looks to be a premature exit or tapering from QE. It’s all too apparent that the Fed would not like this as it diminishes the wealth effect that they have created and are trying to create from a continued rally in the stock market. Investors, who were trading off a whim in the last few weeks, hear the term taper and figure the game is over and start running for the exits. This is not how the Fed see’s their stimulus efforts playing out. They purposely suppress long term interest rates to aid home owners with long term mortgages. When the 30 year mortgage in the US jumps suddenly back over 4 percent, it means trouble for the marginal borrowers who are the target of the feds efforts.