Historically, there are three sales signals in emerging market cycles that investors must see before they start buying again.
For James Barrineau, head of Emerging Markets Debt Relative, it seems that we have already reached these checkpoints.
1. Strong US dollar: clear signal to sell emerging market debt.
“This has already happened,” says Barrineau in his article on the Schroders blog. The US dollar has strengthened more than 7.5% since April 16, while the sovereign debt index denominated in dollars has fallen by 4.9% so far this year and the index denominated in local currency fell by 9.5%
2. The strength of the dollar causes international cracks and in emerging markets: another signal to sell debt from these markets
According to Barrineau, this has also happened.
At this time, countries with greater external financing needs, mainly measured by current account deficits, are under market pressure. Turkey and Argentina are two of those countries.
The Turkish bonds denominated in dollars, remember, have fallen more than 15% and the Turkish lira has fallen more than 25% so far this year. Meanwhile, Argentine bonds in dollars fell more than 16% and the Argentine peso fell by 33%.
3. Monetary policy measures irregularly treat the lack of liquidity: it is the last sign to liquidate what remains of debt of the emerging
“The markets are at this point!” Exclaimed the Schroders specialist, reviewing the countries with the most problems one by one:”The markets are at this point!” Exclaimed the Schroders specialist, reviewing the countries with the most problems one by one:”The markets are at this point!” Exclaimed the Schroders specialist, reviewing the countries with the most problems one by one:
- Argentina received funding from the IMF and modernized its monetary policy, reducing the volatility of the currency.
- Turkey has imposed restrictions on Turkish banks that use LIRA’s in currency exchange transactions, with the effect of increasing trading costs for foreign speculators and taking strong action against investors who place the lira in danger. He also got some funds from Qatar and promised additional tax measures.
- While out of the eye of the hurricane, Indonesia has raised interest rates to slow growth and address market concerns proactively. The results are uncertain and markets struggle to balance their policies to curb investor distrust. In just the first two weeks of August, the sovereign dollar index fell by 1.7% and the local currency index fell by 5%.
4. The turning point comes when the circumstances in developed markets cause a change in liquidity. That’s when you have to buy debt from emerging markets.
The head of Emerging Markets Debt Relative estimates that if international or emerging market stress begins to affect fundamentals in the United States, the Federal Reserve could hint that its cycle of rate hikes could slow down. This is what started the strong recovery of the emerging from early 2016 to 2017.
A slowdown in the United States exacerbated by a too strong dollar or a strong correction of the stock markets for any reason could do the same. The negative effects of the trade war that affect the United States would have a similar result.
When will the turning point come?
“The distance from step 3 to step 4 is the big unknown. The scope of sales we saw in August, however, logically increases the likelihood that the markets have opened a margin of safety for investors, providing some reassurance to potential buyers in emerging markets while we wait for the fourth step to materialize”. Explain.
“As with many inflection points, this moment is probably only apparent in hindsight,” he concluded.