Monday, September 14, 2015

Sudden stop in EM lending - currency cowards in currency wars



All the talk in currency markets has been about currency wars as if the central banks of the world can just adjust prices on a whim based on what they want to see their exports to be in the global marketplace. This is an overly simplistic view especially with respect to the EM currency declines over the last year. In reality, the foreign exchange price is not under the complete control of central banks when there is free flowing capital that moves around the world. 

Money is not flowing into emerging markets. The big cross-border flows of the post crisis period are over. The diversification gain from playing EM under the theme that this time is different is also over.   The cross-border claims in debt were often done in dollars so now that the dollar has increased and rates are expected to go up money flow has stopped. We have seen this story in the 1990's and 19080's.

Forget the long-term benefit from investing in EM. Short-term investors sensitive to yields are moving out of these markets which cause outright declines in growth and increased hedging. These flows are creating the downward price momentum in currencies. Now central banks have to use their reserves to stabilize the investor exits. 

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