With the Federal Reserve looking set to raise rates this coming December it would be negligent to not consider the impact that has been felt by global currencies and more so emerging markets leading up to the decision and most likely for some time after the first rate has been initiated.
We've seen a drastic reduction in the amount of commodities being exchanged between nations one reason being the result of a slump in Chinese economic activity that so many had been hoping would switch on the growth engine globally as well as a stronger than usual Dollar that has made these items expensive in dollar terms to nations except the US.
However thinking about the trillions of dollars created from the Quantitative Easing program executed by the Fed it's no wonder there are worries about the future of emerging market currencies in the light of a proposal to lift rates.
Most of these countries provided a home for capital who would have otherwise earned very low returns for its owners and thus were actively driven towards foreign homes in the hope of finding greater returns.
This in turn has attributed to a big surge in foreign reserve holdings by these nations who now sit on a pile of dollars at a much appreciated price but battling to contain their own home country's currency weakness.
After China decided to intervene in the renminbi on the 24th August 2015 it set a precedent to what lies ahead for most emerging markets although some nations such as Nigeria and Russia have already put in place foreign reserve sell downs for reasons other than the above, it does paint a worrying picture.
The term Quantitative Tightening started being bantered around at the time of the PBOC intervention and immediately I tried to think of this could all mean.
Effectively the trillions of dollars created would need to find their way back to the US but the scale of the easing program does leave one wondering as to how all this money would return without shifting the balance of things and tipping the world economy into a state of flux?
I'm going to post a few charts to explain what I think could possibly help explain what could happen;
Brazil
The country has been hit with a fiscal nightmare after funding two major sports events namely the Soccer World Cup in 2014 and the Summer Olympics to be hosted next year. Added to this is the downturn in commodity prices has put further strain on the situation.
On the graphs above you'll see that the Brazilian Real has touched major resistance and authorities wouldn't want any further depreciation as it could damage the trade balance. We see the foreign reserves have been steady since 2012 but are at elevated levels.
Malaysia
A similar looking chart to the Brazilian economic numbers but this time of the Asian nation Malaysia however notice how the foreign reserves are depleting quickly. This is because the central bank has continuously intervened in the market to try curb more depreciation.
The nation's largest trading partner is China and given the extent to which the downturn has affected most countries around the world you can understand why Malaysia has suffered so badly. The most notable sector that plays an integral role is the oil industry that has been hit hard after the price war between OPEC and the US.
It is clear to see that Malaysia has suffered from two economic setbacks and as a result is fighting back to stabilise the situation, but from the charts above it doesn't seem as if the efforts from the central bank selling off reserves has had the desired effect on the currency.
South Africa
One of Africa's top economies, South Africa has battled with continued labour relation problems as well as mining production declines that have halted the economy from its hay day. The South African Rand has blown out past previous highs and seems to be set around the R14 to the dollar level.
SARB governor Lesetja Kganyago has stated previously that if intervention is required the central bank will step up to the plate and do what is necessary to defend the Rand. If you look at the foreign reserves they have been in decline over the past two years as a result of less commodity sales the most important being platinum.
The SARB has said it will be buying platinum bars as a reserve asset in a bid to mop up the surplus that is hurting the industry.
Conclusion
These three cases are not the only such developments with many other emerging market players facing the same dilemma. I believe that with such a vast amount of dollars invested in them over the duration of the QE program does open up potential for extreme volatility.
I think that with foreign reserve holdings at elevated levels and interest rate hikes doing very little to aid these currencies. Emerging markets will have no choice but to intervene in the foreign exchange market but at the cost of removing the excess amount of dollars in reserve held that provides a cushion for trade fluctuations.
By defending their currencies they would be feeding the dollars created by the Fed back into the system but the real question now is if the actions were to be taken by the central bankers would succeed or could it be a catalyst to a bigger financial disaster?
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