5 min read.Updated: 02 Sep 2013, 09:58 AM ISTBloomberg
Jen warned of a sudden stop of capital to developing nations a month before a retreat that sent rupee to record low
Emerging-market currencies, already headed towards their biggest annual decline since 2008, will tumble another 20% as outflows from India to Brazil accelerate, according to Stephen Jen, who predicted the current rout back in April.
The co-founder of SLJ Macro Partners LLP and former global head of foreign-exchange at Morgan Stanley warned of a sudden stop of capital to developing nations a month before a retreat that sent the rupee to record lows and the real to its weakest level since 2008. Now, Jen says, the worst is yet to come because $3.9 trillion of funds invested in emerging markets in the past four years will leave as the US Federal Reserve withdraws stimulus.
“Whatever selloff you think is reasonable, just double it," Jen, 47, said in a phone interview from London. “It’s the way markets trade: they overshoot."
Fed Chairman Ben S. Bernanke triggered the plunge in emerging-market assets when he signaled on 22 May that the central bank was preparing to reduce its $85 billion of monthly bond purchases, pushing benchmark 10-year treasury yields to a two-year high and luring capital away from riskier nations. China downgraded its growth target to 7.5% this year, which would be the slowest pace in more than two decades, while other emerging economies are also stagnating.
The 20 most-traded developing-nation currencies tracked by Bloomberg are down 7.6% this year, on pace for the biggest drop since 2008, when they lost 14%. The 7.3% decline in the past four months alone compares with a 2.4% gain in the Bloomberg US dollar Index, which tracks the greenback against 10 major peers. Jen sees the further decline coming over the next six months or so.
“The currencies that look more fragile now are just the beginning," Jen said. “They are the first ones to break, but all the others will go as well. In a selloff, it doesn’t matter if a country has superior fundamentals, they will be sold indiscriminately."
India’s rupee has weakened 22% in the past four months, touching a record-low of 68.845 per dollar on 28 August, while Indonesia’s rupiah plunged 12% and reached 10,955 per dollar, the weakest level in more than four years, on the same day. Brazil’s real dropped 19%, falling on 21 August to 2.4549 per dollar, the weakest level since December 2008.
The real, rupee and rupiah, together with the South African rand and Turkish lira, were dubbed the fragile five currencies by Jen’s former colleagues at Morgan Stanley last month because of their reliance on foreign capital. They’re among the six worst-performers among 31 major peers tracked by Bloomberg over the past four months.
“It’s a question of which currencies will be the dominoes," Jen said. “When fundamental mangers reduce risk when volatility is high, they reduce it across the board. That’s the way it is. Emerging markets are highly correlated."
Not everyone shares Jen’s outlook. Pacific Investment Management Co., which manages the world’s largest bond fund, urged investors to buy emerging-market debt in August.
Binqi Liu at HSBC Global Asset Management in New York, which oversees $15 billion in emerging-market bonds, said she favours the real and rand on bets the recovery in the US will be weak enough to keep a lid on treasury yields. The yield on the 10-year Treasury rose to 2.93% on 22 August, the highest since August 2011.
“After all these selloffs, if you’re a long-term investor, the entry point is not bad," Liu in a phone interview on 20 August. Weaker-than-expected US growth will trigger lower yields, which will support EM at this point. Growth in China will probably turn the corner. That could be another catalyst.
More than $47 billion has left global funds investing in emerging-market bonds and stocks since May, extending the outflow this year to $7.5 billion, according to data last month from EPFR Global. Still, the redemption this year accounted for only 2% of the accumulated $322 billion inflows since 2009.
Foreign investors still hold more than 30% of government debt issued by emerging markets, compared with less than 15% in 2009, according to UBS AG, leaving developing countries vulnerable to capital flight.
“The bad news is that this means foreign investors are still quite long-EM assets in the face of an indifferent return profile," Bhanu Baweja, the global head of emerging-market cross-asset strategy at UBS AG, said in a client note on 21 August. “We can see some distress in EM assets as the exit door here often gets narrower the closer you get to it."
Jen, who experienced the Asian financial crisis of the late 1990s first-hand as a Hong Kong-based Morgan Stanley currency strategist, said that the rupee, rupiah or real could turn out to be the Thai baht of the next currency crisis in EM.
On 2 July 1997, Thailand crumbled under the burden of foreign debt, giving up its defense of the dollar peg. The baht depreciated 22% that month.
The devaluation touched off a crisis across the region, leading to an 82% slump in the rupiah in a year and the collapse of Indonesian President Suharto’s three-decade regime. South Koreans lined up in the street to donate their gold jewelry to help the government.
In 1997, the pressure was on the Thai baht, nothing else, until July, said Jen. The peg broke and thereafter the baht exploded, but so did everything else.
The recovery in the developed world is leaving developing nations behind. The euro-area economy emerged from a record six quarters of recession in the April-to-June period, with gross domestic product (GDP) growing 0.3%. The US jobless rate dropped to 7.4% in July from 7.6% the previous month, the labor department said on 2 August, giving credence to expectations that the Fed will dial back monetary easing.
Excluding China and the oil-rich Persian Gulf states, the current-account balance of emerging markets has shifted from a surplus of 2.3% of GDP in 2006 to a 0.8% deficit this year, the biggest shortfall since Russian debt default in 1998, according to Citigroup Inc.
A student of Nobel laureate Paul Krugman, Jen started his career as an International Monetary Fund economist in 1992 after received his Ph.D in economics at Massachusetts Institute of Technology.
During his 13-year stint at Morgan Stanley, Jen made his mark with studies of big-picture issues ranging from global-trade imbalances to the growth of sovereign-wealth funds. The dollar-smile hypothesis he and former Morgan Stanley colleague Fatih Yilmaz developed in 2001 correctly predicted that the currency will tend to rally during a US recession.
Jen left Morgan Stanley for BlueGold Capital Management LLP, a London-based commodity hedge fund, in 2009. Two years later, he founded SLJ Macro with Yilmaz to invest in currencies and provide consultancy to clients.
Jen flagged the risks of emerging markets as early as January 2011, saying capital flows to developing countries were excessive. Bloomberg’s emerging-market currency gauge peaked at a three-year high that April.
Emerging markets are much worse than people have argued, Jen said. The problem is that it’s an entrenched view and so much money has been in the trade, it’s very difficult for them to get out. People are overweight EM. They’re exactly on the wrong side of the boat.