Emerging markets target inflation risk

Emerging market central banks have stepped up the fight against inflation and falling currencies, helping emerging market equities stage a nascent recovery after falling back into bear territory in recent days.

India’s central bank surprised investors by raising its policy interest rate 25 basis points early yesterday, while Russia’s central bank intervened in foreign exchange markets to support the rouble.

Turkey’s central bank was widely expected to raise interest rates last night, bringing the lira back from an all-time intraday low of 2.39 to the dollar on Monday to 2.26 yesterday.

Minor recovery
The MSCI EM index – the most widely followed emerging market index – also staged a minor recovery yesterday, rising to just under 935 points from Monday's close of 931.6, its lowest since the end of August 2013 and down from its recent peak of 1,044 on October 22. The index has fallen 22 per cent from a previous cyclical peak in early 2011 that marked a rebound for emerging markets from the lows reached during the global financial crisis.

India’s central bank raised interest rates for the third time in six months, responding to sustained pressure on the rupee and accelerating inflation. Turkey’s central bank called an emergency meeting for late last night to address the slide in the lira and signalled it was ready to act on rates to stem the fall.

South Africa, which holds a monetary policy meeting today, may keep rates steady, as inflation remains within the Reserve Bank's target range.

Among the concerns weighing on emerging market investors, several identified China as the most worrying. Manoj Pradhan and Patryk Drozdzik of Morgan Stanley noted: "If deleveraging in China unfolds in a disorganised manner, it would be a source of systematic risk."

Liquidity scarcer
The concern is that as liquidity becomes scarcer, riskier assets such as trust products could see an exodus in funds, triggering defaults.

One trust product, the China Credit Trust, avoided default at the last minute on Monday as a mysterious third party sprang to the rescue, allowing it to repay the principal on high-yield products tied to a struggling coal miner.

But investors are wary, partly because any easing in China growth could hit imports of raw materials from other developing nations.

Other countries may also decide to keep interest rates steady in meetings this week.

Malaysia is expected to hold its rates level today.

The recent market turbulence has prompted some speculation that the US Federal Reserve might hold back from announcing a further reduction, or tapering, of its monthly asset purchases this week.

A weak report on US durable goods orders added to such talk. Orders fell 4.3 per cent last month, although analysts noted the bulk of the decline had come from the volatile commercial aircraft component.

Slight reductions
However, the data prompted only slight reductions to analysts' expectations for fourth-quarter GDP growth – and few expected the Fed to change its tapering stance.

"The probability that the Federal Open Market Committee will surprise the markets by either accelerating the taper process or slowing it down is, at best, only marginal," said Steven Ricchiuto, chief economist at Mizuho Securities. – (Copyright The Financial Times Limited 2014)