Analysis: Emerging markets buffeted by bipolar world

Wed Feb 5, 2014 2:13am EST
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By Mike Dolan

LONDON (Reuters) - Ailing emerging markets are caught between a rock and a hard place - Washington and Beijing to be more precise.

For much of 2013, the investor narrative was that currencies and stock markets from Mumbai to Moscow and Istanbul to Johannesburg were running aground as Federal Reserve largesse ebbed away.

As the Fed slows its printing presses and reins in global liquidity via higher U.S. Treasury yields and a rising dollar, those markets that gained most from the swell of quantitative easing would suffer from its withdrawal, it was argued.

And so it played out. Many of the frothier and most exposed emerging markets shook as 10-year U.S. yields surged more than 100 basis points last year to top 3.0 percent as 2014 dawned and the Fed, finally, embarked on its first 'taper' in January.

Yet the odd thing about the stampede out of emerging markets this year - which sent Turkey's lira, Argentina's peso, Russia's rouble and South Africa's rand all plunging last month - is that it's happened just as Treasury yields went into reverse. They have dropped almost half a percentage point since January 1.

The burst of Treasury buying was all the more remarkable given that the Fed has been buying fewer bonds and foreign central banks - many needing hard cash reserves to intervene in defense of their currencies - were selling more than $20 billion of Treasury securities in the week to last Wednesday.

The causality goes a little haywire at this point.

Did the start of the actual Fed bond taper last month feed such volatility on emerging and western equity markets as to prompt a counter-intuitive flight to safety in U.S. Treasuries?   Continued...

A U.S. 100 dollar banknote is seen on top of 5 and 10 lira banknotes in this illustration picture taken in Istanbul January 28, 2014. REUTERS/Murad Sezer