The global capital market has turned upside down. The Hong Kong Economic Journal’s investor diary looked into what economist Nouriel Roubini dubbed as a “mini perfect storm”, and found that dealing with the situation is far from being a simple task.
Capital outflows from the emerging markets actually started ever since Ben Bernanke implicitly revealed the Federal Reserve’s plan last summer that it will soon taper its bond purchases, putting an end to the use of quantitative easing measures. As data at UBS A.G. showed, global emerging market funds have posted a net capital outflow of about US$2.4 billion last week, taking the total outflow to US$20.6 billion in the past 13 weeks. The last time such a long period of capital outflows was witnessed was in 2002. Meanwhile, a capital influx to developed markets has been prevalent, heralding a decoupling between the two markets.
Based on investors’ view that the Fed may raise the fed fund rate sooner if the US economy picks up its pace of recovery, the yield for longer-term US Treasuries has been on the rise over the past 13 weeks. The yield of 10-year Treasuries, for example, rose to 3 percent in December from 2.5 percent the previous month.
Hedge funds and other institutional investors’ extreme confidence in the further rise of US stocks and Treasury yields can be well observed from the open position in the futures markets. The short position of the Treasuries has reached a record high since the third quarter of 2008, data at the US Commodity Futures Trading Commission showed.
However, there are also signs that certain market assumptions may be under test. Clues can be found in the rebound of the Japanese yen and US Treasuries prices as well as a relatively stable gold price. In fact, the yield of 10-year Treasuries plunged below 2.8 percent when the S&P 500 index posted last Thursday and Friday its biggest two-day drop since June last year.
With investors’ obviously excessive bets on higher US stock prices and falling bond prices, a sudden adverse change in the market situation can easily send them scrambling to square positions and trigger a massive short squeeze in the Treasury market.
An institutional investor, probably a macro hedge fund in London, is said to have bought last Wednesday 600,000 eurodollar put option contracts due in April, on top of some 30,000 open-position contracts it currently holds, betting that market participants will then have a much higher expectation on the levels of the fed fund rates in 2016. The bet shows the investor’s anticipation of a fast recovery in the US economy in April, fueling market expectations of a Fed rate hike much earlier than previously expected.
But right after it raised its bets, China’s purchasing managers’ index fell below the 50-point watershed in January, signaling a contraction in the nation’s manufacturing sector. Argentina’s removal of its foreign exchange control also accelerated fund outflow from emerging markets. US interest rate hikes and higher yields of Treasury, a traditional safe haven, now look less certain.
On a separate issue, certain investment banks introduced the concept of compartmentalization, which groups together various emerging markets with similar attributes, in a bid to deal with the rising volatility in the global market. For example, Argentina, Venezuela and Ukraine are put together to reflect their high inflation rates and higher risk profile. Somehow their problems could be traced to their poor management of both the political and economic spheres.
Another group comprises countries such as Turkey, South Africa, Peru, Chile, Indonesia and Thailand, which overspend and rely heavily on foreign financial sources to an extent that they will be most affected by the US tapering. The third group includes emerging markets like Hungary, Romania and Croatia whose prospects depend a lot on the stability of the euro zone.
Obviously, compartmentalization seeks to divide the problems in emerging markets into domestic and regional issues for the sake of containing investment risks. But, as can be discerned from recent market fluctuations, it is highly doubtful if such strategy can be relied upon.
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