Over the last few weeks, and accelerating late last week and early this week, it looked as if a full bore run on emerging markets was in progress. Now with the yen taking its biggest dive in two decades and carry trade unwinds a temporary thing of the past, emerging market and currencies are staging a peppy rebound.
While some argue the crisis has passed, others are not so certain. This comment came as an aside in a Financial Times story today on the slingshot recoveries today:
Themos Fiotakis, economist at Goldman Sachs, said that in spite of the strong rally in risky assets, global uncertainties remained. “In a typical emerging market crisis, central banks would raise rates,” he said. “This would stabilise local currencies and cause local curves to invert.”
But the current turmoil, Mr Fiotakis said, is not being driven by EM fundamentals, but rather by funding strains in G10 countries. “If foreign capital inflows remain constrained independently, excessive rate hikes could prove less effective in stabilising local assets and could pose downside risks to growth in the medium term.”
Iceland raised interest rates on Tuesday by a massive 6 percentage points to 18 per cent in a bid to support the krona and please the International Monetary Fund, which Iceland has asked for a $2bn stand-by loan. The rate move mirrored a sharp tightening by the Hungarian central bank last week to stem a steep decline in the forint.
Hungary, which has also turned to the IMF for aid, warned on Tuesday that its economy could contract by as much as 1 per cent in 2009. But concerns about future emerging market growth were put to one side and the MSCI EM equities index bounced about 5 per cent off a four-year low.