Fragile Five Unravel as Developing Economies Suffer
Comment of the Day

August 08 2013

Commentary by Eoin Treacy

Fragile Five Unravel as Developing Economies Suffer

This article by Ye Xie and Newley Purnell for Bloomberg may be of interest to subscribers. Here is a section
Morgan Stanley's strategists named South Africa's rand, India's rupee, the real, rupiah and lira the “fragile five,” because their countries are finding it increasingly difficult to attract foreign capital to finance trade deficits.

Emerging countries accounted for eight of the 10 worst performers among 31 major currencies tracked by Bloomberg since May 7, with the real sliding 13 percent and the rupee losing 11 percent, touching a record low this week. Gains over the past three months were led by a 2.7 percent jump in Japan's yen and increases of more than 1 percent for the Swiss franc and euro.

The 17-nation euro-region economy will grow 0.1 percent in the second quarter, ending an unprecedented six straight quarters of contraction, according to the median estimate in a Bloomberg News survey before official data on Aug. 14.

Economists predict 1 growth for the area in 2014 after a 0.6 percent contraction this year. The largest emerging economies of Brazil, Russia, India and China will expand 5.9 percent next year compared with 5.7 percent in 2013, according to the median estimate in a Bloomberg survey.

Eoin Treacy's view In the decade from 2002, US Dollar, British Pound and Euro investors in emerging and commodity related markets could rely on the potential for capital market and currency appreciation. However, over the last year this dynamic has changed with the Dollar, Euro and Pound developing base formation characteristics. Meanwhile, previously firm currencies are being targeted by their respective central banks because of the loss of competitiveness a strong currency represents.

The Brazilians have been defending the $1.60 area since at least 2008; suggesting that while they will tolerate a weaker currency, the 2008 and 2011 peaks represent a line in the sand for the administration. The Bovespa Index hit peaks above 70,000 in 2008 and 2010 and has been deteriorating since. It encountered resistance near the psychological 50,000 two weeks ago and a sustained move above that level would suggest a return to demand dominance beyond the short term. Today's strength in both the stock market and currency are encouraging provided the low near 45,000 holds. The strength of the US Dollar has exaggerated the redenominated chart's performance over the last few years.

The Indian Rupee has become so weak that it is now a political liability, having deteriorated by 40% against the Dollar since 2011. The currency's decline has thrown the country's persistent current account deficit into particularly sharp focus. The local currency strength of oil and gold's allure as a store of value are both issues for the administration who was rumoured to have sold Dollars to support the currency today. A sustained move below the 200-day MA would be required to question medium-term Dollar strength. The banking sector has fallen victim to the RBI's attempts to squeeze speculators and is likely to be a lead indicator of a change in sentiment. While currently deeply oversold, a break in the progression of lower rally highs will be required to check the downward bias. In US Dollar terms, the Nifty Index is falling towards the lower side of a more than yearlong range.

The US Dollar has rallied by more than 50% against the Rand since 2011 and a sustained move below the 200-day MA would be required to question medium-term potential for additional strength. To a certain extent, the stock market has been sheltered from currency weakness by the fact that the foreign affiliates of major multinationals have such a high weighting on the JSE. For example BHP Billiton, British American Tobacco, SAB Miller and Richemont are the four largest weighting on the Johannesburg All Share and represent 42% of its market cap. Barclays, Vodafone and Mondi also represent significant weightings. In local currency terms, the Index has been consolidating mostly above the 200-day MA since February and a sustained move below it would be required to question medium=term upside potential. In US Dollar terms, the Index has been rangebound since 2011.

The US Dollar bottomed against the Indonesian Rupiah in 2011 and has found support in the region of the 200-day MA on successive occasions since. While somewhat overbought in the very short-term, a sustained move below the trend mean would be required to begin to question medium-term US Dollar dominance. The Jakarta Composite has been ranging in the region of the MA since late June, but it will need to continue to hold above those lows if the benefit of the doubt is to be given to the medium-term uptrend. In US Dollar terms, the Index continues to extend its decline back into the underlying range.

Turkey has made headlines as a gateway to the Middle East over the last decade but this has not stemmed the decline of the Lira which remains on a medium-term downward trajectory. A break in the US Dollar's progression of higher reaction lows would be required to begin to question the consistency of its advance. Following a steep decline, the National 100 Index has been ranging below the 200-day MA for the last six weeks. A sustained move back above 80,000 will be required to question the medium-term downward bias. The US Dollar denominated Index has a relatively similar pattern.

By contrasting the local currency and US Dollar charts for the above countries we can deduce that currency movements are likely to play a much more important role over the next number of years than they have over the last decade. Additionally, the relative strength of the US Dollar has undoubtedly played a part in Wall Street's outperformance this year.

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