By Kyle Hulett, Sygnia’s Head of Asset Allocation
Over the past few days, the rand has weakened by 10%, the Russian rouble by 9% and the Turkish lira by a massive 26% relative to the US dollar. On a year to date basis the rand is down almost 11%. This broad emerging market contagion has affected equities as well, with the MSCI Emerging Market Index down 17% from its January peak. China’s Shanghai Composite Index entered a bear market in July, having fallen more than 20% from the January peak, a technical definition of a bear market, while Turkey has been in a bear market territory since May.
In US dollar terms equity markets in Brazil, Russia, South Africa and Nigeria markets followed the others on Friday. The rand has also broken through the psychologically important R14/US$ level.
The three main catalysts for the sudden acceleration of the sell-off in emerging markets have been US President Donald Trump’s tweet attacks on both Turkey and Russia, higher than expected US inflation numbers, as well as additional trade tariffs on China.
I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!
— Donald J. Trump (@realDonaldTrump) August 10, 2018
The lira fell as Trump doubled tariffs on Turkish imports of aluminium to 20% and steel to 50%.
The breakdown occurred after Turkey refused to release a detained US pastor, Andrew Brunson, who is on trial in Turkey on terrorism charges. Another explanation has to do with the fact that a prior fall in the lira has offset some of the effects of initial sanction levels. Turkish President Recep Erdogan further unnerved investors by claiming that a shadowy “interest rate lobby” and Western credit ratings agencies are attempting to bring down Turkey’s economy.
European banks’ exposure to Turkey’s foreign debt and local operations are raising concerns of contagion risk.
The rouble tumbled to two-year lows after the US State Department indicated that it would impose new sanctions on Russia after determining that Moscow had used a nerve agent against a former Russian double agent, Sergei Skripal, and his daughter, Yulia, in Britain. The sanctions come into effect in three months if Moscow fails to allow on-site inspections and will include downgrading of diplomatic relations, suspending the state airline’s approval to fly to the US and cutting off nearly all exports and imports. Separate draft US legislation introduced last week proposes curbs on the operations of several state-owned Russian banks in the US and restrictions on their use of the US dollar. Russian Prime Minister Dmitry Medvedev said that these steps would be considered a declaration of economic war.
At the same time US core inflation rose at the fastest pace in 10 years in July, which means that the US Federal Reserve is likely to increase interest rates at a more rapid pace.
However, the negative economic impact of a sell-off of South African assets cannot be underestimated. A weaker rand makes imports more expensive, which means higher prices, including petrol prices, and higher inflation, always a negative for consumer spending. If inflation rises too high it is likely that we will see the return of higher interest rates as well.