It seems that the emerging market (EM) rally is over, at least for some time. The segment nicely survived last year’s Fed rate hike cycle. Broader emerging market fund iShares MSCI Emerging Markets ETF (EEM - Free Report) returned 35.6% in 2017, marking its best year since 2009, thanks to a subdued greenback and synchronized global growth.
But the story appears to be changing now. PowerShares DB US Dollar Bullish ETF (UUP - Free Report) was up 3.4% in the last one month (as of May 7, 2018). As a result, EEM is down about 2% this year. Last week, U.S.-based emerging market equity funds have seen their “first weekly outflows of the year”, according to Reuters (read: Dollar ETFs Bounce Back: Can the Rally Continue?).
Taper Tantrum in the Cards?
Pressure in the emerging market space sparked off memories of the 2013 taper tantrum. Emerging market investments were badly beaten down by talks of a Fed taper in early 2013. Higher rates in the United States along with a stronger dollar dulled the appeal of emerging markets around the globe, leading many to sell their shares.
This year looks to be a repetition of those days. U.S. 10-Year Treasury bond yields crossed 3% in late April for the first time since January 2014. J.P. Morgan’s chief executive Jamie Dimon expects the benchmark bond yield to touch 4%.
The logic is if economic growth stays steady and inflation picks up, the Fed may act faster than expected. Notably, the Fed believes that the economy is likely to attain the central bank’s 2% goal in the medium term.
The Fed has already enacted a hike in March and is expected to enact two more in 2018, of which the second is expected at the next policy meeting in June (read: Yield Curve Steepens After Fed Meet: ETFs to Tap).
In particular, the U.S. economy has been enjoying an edge over other developed regions, which made the U.S. dollar relatively more compelling. Bank of America Merrill Lynch noted that the greenback is likely to ascend versus EM currencies as developing-nation central banks have been unwilling to hike rates.
EM Currencies Under Trouble
April has been a downbeat month for emerging market currencies. WisdomTree Emerging Currency Strategy ETF (CEW - Free Report) was down 2.1% in April. Some of the heavily downtrodden EM currencies have been the Turkish lira, South African rand and the Argentine peso (read: EM ETFs: What You Need to Know Before Investing).
Apart from a higher dollar, some country specific issues are also affecting these currencies. For example, Argentina and Turkey are facing blazing inflation pressure. Tiff between the United States and China on the import tariff issue and the likelihood of a trade war are negatives for the EM space this year.
Are EM Rate Hikes in Queue?
Policy makers in Argentina hiked raising rates three times to 40% to hold the sliding peso. Russia held interest rates steady at 7.25% in its meeting on Apr 27, after five successive cuts. Turkey looks to lower its current account deficit and Indonesia is utilizing reserves to boost its currency.
EM ETFs That Were Thrashed in Last One Week
iShares MSCI Turkey ETF (TUR - Free Report) – Down 7.8%
Global X FTSE Greece 20 ETF (GREK - Free Report) – Down 5.5%
iShares MSCI Poland ETF (EPOL - Free Report) – Down 4.2%
First Trust Emerging Markets Equity Select ETF (RNEM - Free Report) – Down 3.6%
ALPS Emerging Sector Dividend Dogs ETF (EDOG - Free Report) – Down 3.6%
Global X SuperDividend Emerging Markets ETF (SDEM - Free Report) – Down 3.4%
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