Can Rate Hikes Save These Emerging Market ETFs? [Ishares Msci Turkey Inv Market Index Fd, iShares MSCI South Africa Index (ETF)]

February 11, 2014 3:45pm NYSE:CEW NYSE:EPI

percent rateThe going was extremely tough for emerging market currencies in 2013 with the WisdomTree Emerging Currency Fund (CEW) shedding about 6% of its value. Steeper decline had been noticed in some currencies like Indian rupee (down 12.6%), Turkish lira


(down 18.6%) and South African rand (down 20.4%). The firmness in dollar following the onset of QE taper talk in 2013 and a general risk off trade created this malaise.

On top of it, all these currencies were down in low-single digit in the last 15 days of January thanks to the Fed’s long-apprehended (by investors) decision to scale back QE program from January.  With a bit of risk off trade, Emerging markets seem to have lost their appeal, especially as U.S. treasury yields continue to rise. With a possibility of a faster QE trimming in the course of 2014 and flight of foreign investments from these developing nations, currencies are likely to weaken further in the coming days.

Rate Hike a Common Resort

Amid such a backdrop, central banks in Turkey and South Africa stunned investors by raising key rates, to prop up their struggling currencies on January 28 and 29 respectively. India also joined the bandwagon around the same time, but the step was taken to contain its stubbornly high inflation. Whatever be the prime cause, Indian rate hike should support its ailing currency.
Let’s see in details how proactive the individual central bank was in shoring up their stressed currencies (read: 3 Currency ETFs Crushed in Emerging Market Rout):

Turkey 

Turkey raised its overnight lending rate sharply on January 28 from 7.75% to 12%, one week repo-rate from 4.5% to 10% and overnight borrowing rate from 3.5% to 8%. Soon after the announcement, Turkish currency lira went to rallying and gained as much as 3%,  though it lost some of those gains later.
Higher rates will attract foreign investors to lira-denominated investments which will in turn boost the value of the currency.

South Africa

The scenario was little convincing for South Africa which went for just 50 bps rate hike to 5.5% on January 29 long after 2008. Notably, the South African rand has depreciated to a five-year low against the dollar in recent days losing about 25%in the last eight months. As per analysts, countries like South Africa need to protect its currency desperately as 40% of its total outstanding stock of debt is held by non-residentsWithout such measure, it will be hard to keep up the inflow of foreign capital over the long term. 

India

On January 28, the Reserve Bank of India (RBI) unexpectedly hiked its repo rate by 25 bps to 8% in a bid to contain inflation. With the latest hike, India has raised its repo rate by the same quantum thrice in the five trailing months (read: A Weaker Rupee–Boon or Bane for India ETFs?).

Are Rate Hike Measures Justified?

No doubt, rate hike will rein in these countries’ growth rates. This is surely no good news especially at a moment when growth rates of emerging nations are slowing and investor focus has shifted toward developed nations where the economic dynamics are improving steadily. Quite expectedly, markets of the concerned nations did not welcome the step on the possibility of sluggish growth. A substantial fall in ETFs related to the respective countries affirms this fact.

Investors should note that the only pure-play on Turkey iShares MSCI Turkey Investable Market ETF (TUR) slumped 3.24% at the close of January 29, the biggest South African fund iShares MSCI South Africa ETF (EZA) tumbled 3.79% while major Indian ETFs like WisdomTree India Earnings Fund (EPI),iShares India 50 (INDY), iShares MSCI India (INDA) and PowerShares India(PIN) lost 1.61%, 2.25%, 1.91% and 2.20% respectively.

Bottom Line 

Such measures might help in boosting investors’ confidence in the emerging markets, though at the cost of reduced growth, especially in the current environment when emerging currency devaluation is a large factor.

On a positive note, even after being reduced, growth rates are still decent at about 4% to 5% in emerging nations, better than many fast-growing developed countries. However, barring some initial euphoria, Turkish lira and South African rand failed to hold up the rally versus the greenback. With the Fed announcing another round of $10 billion cut in the QE program, the USD has once again taken the center stage.

In a nutshell, the greenback will rule the year 2014. Apart from the dollar, no other currency is promising outright appreciation relative to the USD.  It is advisable to stave off the emerging market currency exposure. Investors with high risk appetite wanting to tap these markets, should be extremely choosy and take closer look at each and every Fed move.

This article is brought to you courtesy of Eric Dutram.


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