A global crisis has begun while Trump makes America great again
Trump has wreaked havoc with hedge fund portfolios and he hasn’t even taken oath yet. Longs in bond proxies, Gold and Tech have gotten smashed while shorts in Financials, Industrials, Transports and Materials have probably finished off most people’s 2016. If this is the trailer to what his Presidency will look and feel like, the hedge fund and medical world better brace itself to deal with heightened cases of bipolar disorders and unfunded patients respectively. All things being equal the SPX rally looks inspiring. At new All-Time highs, US stock holders are happy. There are no sellers. Everyone is making money. One feels like going All-In. Throw all the chips into the pot. What can possibly go wrong? Very little. But something always does. It is just not meant to be this easy. Sorry. We know it sounds lame. But second level thinking i.e. thinking that is not so obvious is telling us to look at something closely. Where’s the market’s third rail placed right now?
And that something is EM FX. Trump’s victory has a dark macro angle that the US market is not bothered about just now. And that angle is the Chinese Yuan, Indian Rupee, Brazilian Real, Malaysian Ringgit, Thai Baht, South African Rand, Turkish Lira, Mexican Peso, Indonesian Rupiah and the Russian Rouble. It is our contention that these currencies have already begun a period of depreciation. And this is going to accelerate in coming months and quarters. We see Dollar strength against Emerging Market currencies as the single biggest threat to global asset markets. And this threat is real. It is not imminent either. It’s born and walking already.
With tons of EM debt denominated in US Dollars today, the world is staring at a multiple of the liquidity squeeze it last saw in the mid to late 1990s. Back then, EM wasn’t a big enough asset class. A crisis in Asian currencies took time to impact the developed world. In fact, if you picked any EM FX market and looked at it from 1991 to 1996, all you saw was a steady period of depreciation. Nothing enough to shake people. But post that five year period, a dramatic move begun in the month of Dec 1996. By 1997 and the summer of 1998, it had taken the shape of a complete rout. Fast forward to today and this is what we see.
EM FX started dropping from 2011. Five years later and it’s still falling. Now this fall is about to accelerate. The two charts below show you everything you need to know.
Building on this thesis further from here
The chart on the left shows you the MSCI EM Equity Index (in blue) and the JP Morgan EM FX Index (in red). Notice how divergent the two lines have been in recent weeks. New highs in MXEF have been met by lower tops and now a sharp decline in FXJPEMCS. This is a material development. At no point in its entire history has EM ever been able to rally against the backdrop of a weak FX environment. It’s not about to do that this time either. EM FX is pointing aggressively downwards. Take a look at an example of the Real on the right. We suspect that the next big move is a sharp period of BRL depreciation. And this is valid for every EM currency.
An FX and debt crisis in Emerging markets has begun. A rising Dollar is a big liquidity squeeze. Many bonds have already dropped a lot. Rising rates with depreciating currencies is a heady cocktail. They feed each other. EM is where the world had its robust consumer. The Indian middle class demand for goods & services has collapsed (maybe that’s why Gold is getting smoked as it’s lost its biggest buyer). How will the world fill up this hole?
Source Data: Bloomberg, Company Accounts, Third Party Industry Research. Author: Ashwani Mathur
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