“Only when the tide goes out do you discover who has been swimming naked”. Our favorite piece of wisdom from Warren Buffett is particularly relevant this morning – many market participants are desperately trying to cover themselves as last week’s emerging markets plunge becomes a full-scale rout.
An abrupt tightening in monetary conditions across the rich world is intersecting with an expected reduction in China’s demand for raw materials to trigger widespread selling across Asia and Latin America, and is beginning to spill over into growth-sensitive assets in the developed markets.
The Phillipine peso and Malaysian ringgit expanded the list of victims overnight, falling to three year lows, joining the Argentine peso and Turkish lira in the deep discount bin as capital flows shift into reverse.
As traders flee exposed positions, safe havens like the Swiss franc and the Japanese yen are falling upward – potentially unwinding some of the economic gains that have been achieved through lower valuations over the last year.
Thus far, the commodities complex has been relatively unscathed, with copper, gold and oil prices all supported by a slightly weaker dollar – but a continuation of the current selloff could boost the dollar’s safe haven appeal and deliver a knockout blow to the vulnerable raw materials sector.
Broadly speaking, any country that has become reliant on foreign money is now on the wrong side of the sentiment divide. Traders are picking off countries with large current account deficits one by one, smashing the phenomena that has seen credulous Western investors pour funds into tiny economies since the “BRICS” term was coined in 2001.
Although the current liquidity squeeze is likely to abate over the coming weeks, we expect further weakness in many emerging markets over the coming year. Unsustainable credit booms in China and within regional economies themselves have created deeply unbalanced incentives that will take time to correct – and the transition to normalized will unquestionably be painful.
As such, we would urge businesses with large exposures to consider minimizing risks (and locking in attractive levels) with tools like non-deliverable forwards. Many of the world’s most volatile currencies can be hedged relatively efficiently in the offshore markets – and businesses that understand this can build a tremendous competitive advantage against those which don’t.
Canada:
North of the border, Justin Bieber’s arrest continues to weigh on the Canadian dollar, with analysts expecting further weakness in the weeks ahead as US courts levy ever larger fines against the rapidly fading star.
The currency is receiving some respite however, with Friday’s higher-than-forecast inflation numbers pushing rate cut expectations into the future. Canada’s relatively strong balance sheet is also helping to attract inflows from investors seeking safety from the turmoil afflicting other markets – at the moment, any port in the storm will do.
As discussed over the past few weeks, it appears that the 1.1000 mark has now become a “pivot point” for the Canadian dollar, temporarily filling the role that 1.0000 did for much of the post-crisis era. For exporters, rates weaker than 1.1000 should generate attractive selling opportunities, while importers should consider seizing the moment whenever the loonie moves above this threshold.
The week ahead contains a slew of potential volatility triggers, with Bernanke’s last Federal Reserve announcement on Wednesday likely to generate the most trading activity. Most observers expect another 10 billion dollar reduction in asset purchases, but a recent deceleration in data has sown enough doubt to make this an uncertain prospect.
Thursday and Friday will bring fourth quarter growth numbers for both the US and Canada, potentially affecting the monetary policy path in both economies. If the US continues to outpace Canada, a leg down toward 1.15 is a distinct possibility. If the two converge, a break back above 1.10 would also be back on the table.
Lastly, Friday’s Chinese manufacturing data will be watched extremely closely by many market participants. In the event that further weakness is seen, this week’s selloff will accelerate into the weekend – and hedgers that are unprepared could find themselves on the wrong side of the market comeMonday. Trailing limit orders are strongly encouraged.
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