Emerging markets and currencies, we have all heard repeatedly, are lying prostrate these days, trampled under hoof as investors stampede back to the alleged safety of the United States, Europe, and Abenomics-era Japan. The mere rumor of less quantitative easing by the US Federal Reserve, everyone knows by now, has produced a great sucking sound of liquidity being hoovered from developing economies to the metropol.
Industrious researchers at Morgan Stanley whipped up a new financial catch phrase
, the “Fragile Five,” to denote the peripheral currencies at severest risk against the unstoppable dollar. That would be the Brazilian real, Indian rupee, South African rand, Indonesian rupiah, and Turkish lira. Pundits with a historical bent recalled that rising US interest rates, the kind that are expected soon again, helped set off the Latin American financial crisis of the 1980s and the Asian debacle of the late 1990s.
All that analysis looked sharp two or three whole weeks ago. Emerging market equities did have one exceptionally nasty week in mid-August, losing more than 6% in five trading sessions, as measured by the popular iShares MSCI Emerging Markets ETF
(NYSEARCA:EEM). But they have recovered that ground and more, rising by 9% since Aug. 21. The S&P 500
(INDEXSP:.INX) gained less than 2% during that interval. Every one of the Fragile Five currencies has ticked back up against the greenback.
So what happened? Improving economic data out of China hasn’t hurt the emerging world. But the most dramatic turnaround has come from Brazil. The ever-volatile No. 7 world economy seemed deep in a depressive phase until Aug. 22. Growth had slowed steadily since 2010 thanks largely to declining commodity demand from top customer China. President Dilma Rousseff was making a half-baked leftist hash of economic policy, besmirching the legacy of her legendary mentor Luiz Inacio Lula da Silva. The real had lost a frightening 20% of its value relative to the dollar over the previous five months. A Bloomberg blog post
entitled, “Can Brazil’s Currency Be Saved?” led with observation: “One feels almost sorry for Brazil central bank President Alexandre Tombini these days.”
Then Tombini struck back. He announced that Brazil would spend $60 billion from its $370 billion in reserves to mop up greenbacks and boost demand for local currency. He also announced a 50-basis-point hike in the prime lending rate (to 9% per annum), with a hint of more to come, if necessary, to stem 6.5% annual inflation and lift the real out of its deep funk.
Tombini’s strategy would not be the first choice for any central banker. Brazilian GDP growth skidded to 0.9% last year from 7.5% in 2010, and this year may limp back to 2% -- not exactly the time to take away the punch bowl by announcing stiffer interest rates. A weak currency is, of course, good for exports, which Brazil needs to close a current account deficit that was close to 3% of GDP last year. But the floundering real is punishing Brazilian corporations with hard-currency debt, and making inflation control next to impossible. So the central banker chose what looked like the lesser evil.
In the short term, Tombini’s gambit has succeeded beyond most expectations. The real has jumped by about 7.5% against the dollar in the past two and a half weeks. Stocks followed the currency and then some, the widely traded iShares MSCI Brazil Capped ETF
(NYSEARCA:EWZ) gaining 14%. Brazil’s rally produced positive contagion with about a week’s lag. The much maligned rand has risen by 4.2% since a trough on Aug. 28, the roundly abused rupee by 7.5%.
Investors may be realizing that, unlike in the 1980s or '90s, today’s emerging markets are not helpless against a dollar that's in the monetary gym building up bulk. Far from it. The top-12 developing economies, excluding
China, hold $2.9 trillion
in currency reserves, according to Bloomberg, much of it in US Treasury bills. China has another $3.5 trillion under its own mattress.
Tactically, these massive savings, which have doubled over the past decade, allow a country like Brazil to spend $60 billion supporting its currency without, monetarily speaking, breathing hard. Strategically, they insure, or should insure, a two-way conversation between the US and the rest of the world on optimal policies for everyone. If the big emerging markets feel too disadvantaged by Fed policy, they can wreak abundant havoc with US debt just by shifting their weightings a few percentage points.
Fed officials have signaled that they have enough headaches trying to steer the US economy without worrying about everyone else on the planet. That would seem logical enough if the US were not living off trillions in Chinese, Brazilian, Russian, and even Indian savings. Emerging markets these days can fight back.
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