Emerging markets (EM) will not be exposed to a repeat of the notorious 2013 incident dubbed the ‘taper tantrum’ according to Gustavo Medeiros, deputy head of research at listed EM-focused asset manager Ashmore.
Mr Medeiros argued that the Federal Reserve (the Fed) is unlikely to reduce quantitative easing during the recovery period of the pandemic, despite increasing yields on US treasury bonds since July last year.
Talk of a taper tantrum has gained increasing momentum among analysts and fund managers, with Shane Balkham, chief investment officer at Beaufort Investment, suggesting that there was a possibility of a sell-off in equity markets despite the continued support from central banks.
Mr Balkham said: “The supportive stance from policymakers will likely remain in place until the vaccines have paved a way to some return to normality. However, there will be a risk of another ‘taper tantrum’ similar to the one we witnessed in 2013, and this is our main focus for 2021.”
Gaurav Saroliya, director of macro research at Oxford Economics, also suggested that a taper tantrum remained a possibility, even if not intended. He felt the Fed could give rise to a ‘policy accident’ by merely fanning speculation.
The case for EM resilience
In his analysis on the subject matter published last month, Mr Medeiros outlined four reasons why fears of a taper tantrum are misplaced. His reasons include the published intentions from the Fed, the position of EM external accounts, the low price of EM currencies, and the high price of commodities.
Mr Medeiros believes that the Fed will remain patient as the global economy begins its revival process, and that even if there were imminent policy reversals, EM is in a much stronger position to withstand such instability compared to eight years ago.
While the yield on 10-year US treasury bonds has increased from an all-time low of 0.53 percent on 31 July 2020 to 1.34 percent this month, with real interest rates increasing from -1.03 percent to -0.82 percent, Mr Medeiros pointed to the released minutes from the Federal Open Market Committee, which suggested that US fiscal policies would remain at strongly accommodative levels at least until the Covid-19 crisis is in “the rear-view mirror”.
He contrasted this to 2013, where the path to recovery from the 2007-09 financial crisis was considered clearer than it is during the current economic downturn. During that time, the Fed had been discussing the tapering of government bonds for months prior to the taper tantrum. Its then chairman Ben Bernanke even announced during a Congressional hearing that it would consider reducing the pace of monthly bond purchases. Equivalent communications have not been made this year.
Alongside Fed policy, the deputy head of research believed that EM was in a more secure situation and could mitigate the consequences of any decisions the US made following the recovery to alter its policies.
He observed that EM countries are now running average current account surplus to the tune of 1.3 percent of GDP, which is close to the strongest level in 20 years. Just before the taper tantrum in 2013, the average EM country ran a current account deficit equivalent to 1.8 percent of GDP, which was close to the lowest levels since 2002. He forecasts that the size of the surplus means that higher external funding costs associated with rising US Treasury yields will impact EM countries far less than previously expected.
Moreover, Mr Medeiros suggested that EM currencies are trading close to their all-time lows whereas in 2013, EM currencies were relatively expensive. Additionally, commodity prices are moving higher as the global economy is rebounding from the covid-19 shock. These factors would in his view, allay concerns of a temper tantrum.
Headwinds for EM investors
Speaking to Fundeye, Mr Medeiros acknowledged that Fed policy could change following the recovery, even if he ruled out any imminent changes.
Commenting on the current levels of fiscal stimulus pumping through developed markets, he said: “It is far too early in the cycle for the Fed, European Central bank and other major central banks to normalise monetary policy. Fiscal stimulus will remain in place, demanding more purchases of government bonds. Any taper tantrum situation is likely only once we are much more advanced into the economic recovery. It is hard to measure when they will choose to reduce the pace of bond purchasing, but we are likely to be at least one to two years away.”
Nevertheless, he did recognise that talk of a taper tantrum and negative speculation could result in outflows in the short term, even if he was convinced the long-term case for EM investment would remain highly attractive.
Mr Medeiros explained: “Negative sentiment to EM invariably leads to outflows due to deep-rooted biases and prejudices, and outflows leads to volatility which feeds into negative sentiment. However, over the medium term, fundamentals prevail as the outflows will lead to price dislocations which long term investors can exploit.”
He also admitted that real interest rate increases could effect key markets even if a wide-scale taper tantrum did not fully materialise, meaning the current investment conditions could cause people some reasons for concern.
The deputy head of research added: "If real interest rates were to rise another 100bps from here, the countries that are more dependent on foreign capital to fund fiscal and current account deficits would struggle the most. Turkey is the only large economy that runs a large current account deficit. But there are a handful of frontier economies in Africa, Asia and Central America that could be hit. They are not large enough to disrupt the asset class individually, though."
He did, however, reiterate the significance of the current account surplus in emerging markets, pointing to it as one of the key differences between today's situation and the disastrous outflows during the taper tantrum.
Mr Medeiros concluded: “It is very important to the extent that EM doesn’t have to do a huge adjustment like it did between 2013 and 2015, should funding conditions deteriorate. Of course, the current account surplus doesn’t insulate EM from bouts of volatility like we’re experiencing today after 10-year UST had a flash crash to 1.6085 percent and quickly retraced to 1.52 percent (+15bps). But the current account surplus does prevent EM to go into a negative feedback loop like we had in 2013-15. Furthermore, high and rising commodity prices is boosting the terms of trade of commodity exporters in Latin America, supporting a corner of the world where valuations are very attractive.”
