Stocks, Emerging Market Currencies Fall Sharply

CNBC reports:

U.S. stocks fell sharply and Treasuries rallied on Friday, with the Dow Jones Industrial Average tumbling triple-digits for a second session and posting its worst week since November 2011, as investors pulled money from emerging markets and other assets viewed as risky.

As Wall Street's faith in some of the world's largest developed countries unraveled, currencies of those nations were hit, with Turkey's lira falling to a record low against the dollar, and Argentina's peso down sharply against the U.S. currency.

"We've touched off by what's going on around the world, so to speak, and are reallocating assets from some of the emerging markets into what is thought of as more reliable," said JJ Kinahan, chief strategist at TD Ameritrade. "It's a safe parking spot," Kinahan added of fixed income.

... "Emerging-market currencies have been coming under pressure causing some to erroneously point out it is because of the Fed taper. It is more because of political instability in countries like Argentina and Turkey, which is just another reason to stay underweight EM," Nick Raich, CEO at the Earnings Scout, wrote in emailed research.

The Telegraph also reports:

The Turkish lira sank to a record low of 2.30 to the dollar as worries about the current account deficit - 7pc of GDP - combine with a loss of confidence in the country's political stability. The Sunni Muslim premier Recep Tayyip Erdogan said on Friday that Turkey is facing "war" within its borders, partly the result of a spillover from the Shia-Sunni conflict in Syria.

Turkey's deputy prime minister Ali Babacan said in Davos that the plunge in the lira was a result of a foreign exchange "repricing process", denying that there had been any capital outflows. However, the country is close to a major crisis with foreign reserves down to $33bn, barely enough to cover six weeks of imports. 

South Africa's rand slumped to 11 to the dollar, and has lost almost 30pc over the past year. Venezuela has been forced to devalue certain controlled transactions as reserves fall to a 10-year low. 

The latest rout turned serious after a 12pc fall in Argentina's peso on Thursday, triggered by the central bank's decision to abandon efforts to support the currency. It was the biggest one-day fall since the crash in 2002, when Argentina left the dollar peg.

But why the blame on the Fed tapering quantitative easing? From the Telegraph article cited above:

The IMF's deputy-director, Min Zhu, said in Davos that the Fund is watching the violent gyrations around the world "very carefully", saying the effect of bond tapering by the US Federal Reserve is causing global liquidity to dry up. 

Mr Zhu said this had combined with a slow structural crisis in a number of developing states that have already picked the low-hanging fruit of catch-up growth, warning that those that resist market reforms "will face trouble".

An internal study by the IMF concluded that the effects of quantitative easing by the Fed had led to a $470bn flow of funds into emerging markets that would not have occurred otherwise. Officials say privately that a sudden reversal as the Fed tapers is a major risk, and could be hard to control.  

... Nariman Behravesh, chief economist at IHS Global Insight, said Fed tapering was the "straw that broke the camel's back" for the BRICS and the emerging market darlings of the last cycle.

"They benefited hugely from the credit boom, a commodities super-cycle propelled in large part by China’s double-digit growth rates and “hyper-globalization” as multinational corporations expanded global supply chains. But all three effects are now falling away." 

"They squandered their opportunity. Productivity has plummeted and they face daunting structural challenges. Without major microeconomic reforms, a return to the BRICS party of the 2000s is unlikely. Turn out the lights,” Mr Behravesh concluded.

The Globe and Mail also explains:

Demand for bonds forces their prices up and their yields down. So by buying hundreds of billions of dollars of U.S. Treasuries, the Fed shoves borrowing costs lower because credit prices tend to be marked against the cost of U.S. debt. But QE also is an attempt to bully private investors into spreading their money around.

When times are uncertain, there is a natural attraction to buy Treasuries, the safest asset on the market. Through QE, the Fed effectively blocks that option, forcing profit seekers to look elsewhere.

After five years of QE, no one is quite sure how out of sync financial markets might be. Some see bubbles everywhere, others see none at all. The “reach for yield” could explain some of the current turmoil in emerging markets.When the Fed was buying bonds indefinitely, investors sought profits in the stocks and bonds of countries such as Brazil and Turkey. But once it became clear the Fed was preparing to end QE, investors recalculated. Many rushed home to the United States, causing volatility in the markets they left behind.

It seems to be a chicken and the egg argument. However, it doesn't appear that the rush to buy Treasuries is motivated as much by profit seeking as a quest for security. This would indicate that the primary mover is insecurity and lack of confidence in the emerging markets, just as stated in the CNBC article cited earlier.