January 29, 2014 / 8:00 PM / 4 years ago

EMERGING MARKETS-Currencies slump as Fed offsets Turkey, S.Africa rate hikes

By Walter Brandimarte and Sujata Rao
    RIO DE JANEIRO/LONDON, Jan 29 (Reuters) - Emerging market
currencies slumped on Wednesday as the U.S. Federal Reserve cut
back further on monetary stimulus, offsetting aggressive
interest rate hikes by Turkey and South Africa.
    Stock and foreign exchange markets from Istanbul to Sao
Paulo remained under stress, with the Turkish lira staging a
short-lived rally that lost steam as investors braced for the
Fed's widely-expected decision to reduce its bond purchases by
another $10 billion. 
    Turkey's massive monetary tightening put pressure on the
most fragile developing countries to follow suit to prevent
jittery investors from running for the exits. But not even
higher returns were enough to stop the exodus as the Fed
continued to mop up the easy money that had been flooding
emerging markets over the past several years.
    "Emerging markets in general will have to offer
significantly higher funding costs in order to stabilize the
dramatic change we are now seeing in net portfolio flows in the
asset class," Citi FX strategist Ishitaa Sharma said in a note.
    The South African rand was down more than 2 percent
to 11.21 per dollar even after the country's central bank raised
interest rates for the first time in almost six years, bringing
its benchmark rate to 5.5 percent from 5.0 percent.
    In Turkey, where the central bank raised all of its interest
rates in dramatic fashion, the lira initially rallied
more than 3 percent but eventually gave up gains before
recovering slightly. It last traded 0.45 percent stronger at
2.243 per dollar. 
    "The Turkish rate move was more aggressive than many people
had expected. That was the good part of the story," said Ulrich
Leuchtmann, head of currency research at Commerzbank in
    "But the market had to force this activity. There is still a
fear in the market that the central bank does not have a
reaction function."
    The moves by the central banks of Turkey and South Africa
followed massive currency sell-offs caused by the prospect of a
further reduction in U.S. stimulus that sucked investor cash out
of the most vulnerable emerging economies. 
    Investors deem real interest rates in these markets too low
to compensate for growing economic and political risks. With
Brazil, Turkey, South Africa and India all holding elections
this year, policymakers are likely to be wary of hiking rates
too much to avoid damaging economic growth.
    Turkish Finance Minister Mehmet Simsek addressed one of
those concerns on Wednesday, saying that economic growth will
not be severely damaged by the rate hikes and that it is too
early to adjust the government's forecast of 4 percent growth
this year. 
    The rate increase follows similar moves across the
developing world, with India unexpectedly raising rates this
week and Brazil and Indonesia already in policy-tightening mode.
    Brazilian officials have sought to distinguish Brazil from
other emerging markets in recent days, reiterating the
government's commitment to sound fiscal and monetary policies.
On Wednesday, a member of President Dilma Rousseff's economic
team stressed that the central bank's tightening cycle was aimed
at curbing inflation, not currency volatility. 
    Latin American currencies resumed a broad sell-off, with the
Argentine peso sliding 2.33 percent on the black market
to 12.85 per dollar and the Mexican peso dropping nearly
1 percent after two straight sessions of gains.
    The Brazilian real closed 0.3 percent weaker at
2.4324 per dollar right before the Fed's decision as investors
worried about the impact of the recent emerging market turmoil
on Brazil's already shrinking economic growth prospects.
    In the futures market, however, the real extended losses
following the Fed's announcement, with the contract for next
month trading at 2.44 per dollar .  
    The debacle of the Argentine peso's official exchange rate,
which last week slumped the most since the country's 2002
financial crisis, is expected to shave at least 0.2 percentage
points off Brazil's gross domestic product this year, Nomura
forecast in a research note. Argentina is an important trade
partner for Brazil and a key market for Brazilian companies.
    The real's losses were cushioned, however, by expectations
that the central bank may soon step up its forex interventions
as the currency nears a six-year low.
    Brazilian policymakers have been intervening in the market
by offering currency hedges in the derivatives market, but
investors are also pricing in another aggressive interest rate
hike of 50 basis points next month that would take the benchmark
Selic rate to 11 percent, according to calculations based on the
domestic yield curve.
    "With bad news at home and the anxiety coming from the Fed,
folks are bracing for the worst-case scenario," said Reginaldo
Galhardo, a manager at the currency desk of Treviso brokerage in
Sao Paulo. "The market also is speculating about when the
central bank will increase intervention to support the real."  
    Emerging market stocks were also volatile. The main MSCI
emerging market index rose 0.25 percent off 4-1/2
month lows, but the Latin American portion of the index
 slid nearly 1 percent. 
    Key Latin America stock index and currency prices at 1912

     Stock indexes                   daily %     YTD %
                     Latest          change      change
 MSCI LatAm          2,876.50        -0.99       -9.23
 Brazil Bovespa      47,556.77       -0.59       -7.67
 Mexico IPC          40,751.42       0.22        -4.62
 Chile IPSA          3,419.50        -1.94       -7.56
 Chile IGPA          17,046.99       -1.75       -6.47
 Argentina MerVal    5,675.22        0.25        5.27
 Colombia IGBC       12,009.48       0.19        -8.12
 Peru IGRA           15,481.97       -0.97       -1.72
 Venezuela IBC       2,796.98        -0.71       2.21
 Currencies                          daily %     YTD %
                           Latest    change      change
 Brazil real         2.4324          -0.28       -3.11
 Mexico peso         13.3900         -0.98       -2.69
 Chile peso          549.0000        -0.60       -4.17
 Colombia peso       2007.0000       -0.22       -3.74
 Peru sol            2.8220          0.00        -1.03
 Argentina peso      8.0000          0.12        -18.84

 Argentina peso      12.8500         -2.33       -22.18

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