Financial markets went through a global cleansing in January, with most markets closing the month deeply in the red.
Despite a better-than-expected earnings season in the United States, a severe meltdown in emerging markets made a risk-averse sentiment grow like a dark cloud over global financial markets, dragging major equity bourses down. After four consecutive months of gains, the Dow Jones Industrial average closed the month 5.3 per cent lower, while the S&P 500 index similarly snapped a run of four-month gains to close the month 3.6 per cent lower.
However, it was the performance of emerging markets currencies and their respective central bank responses that stole the headlines. They triggered the largest global rout in higher-yielding assets in more than five years. Perhaps the biggest loser of the month was the Turkish lira, which fell to an all-time low against the US dollar and was immediately followed by steps to stem the meltdown.
In an emergency meeting, the Turkish central bank ditched its existing plans of eating through its forex reserves, and instead rather aggressively increased its overnight lending rate to 12 per cent from the previous 7.75 per cent.
Similarly, the South African rand dropped to a five-year low before the country lifted its benchmark rates to 5.5 per cent from 5 per cent.
Although the timing of the sell-offs has been rather curious, the large unwind in emerging markets is clearly the result of the Fed’s tapering back in December. Couple these with a weaker flow of growth-related figures from China and the risk-averse environment seems to be gaining momentum.
China’s final HSBC Manufacturing PMI fell to 49.5 from 50.5 – the lowest reading since July last year. This shook Asian markets and was followed by a continuous run of weaker growth indicators from China. Chinese industrial production earlier in the month reported a drop to 9.7 per cent (as opposed to an expected 9.8 per cent from a previous 10.0 per cent) while year-on-year Chinese GDP fell 10 basis points to 7.7 per cent.
Following the weaker-than-expected reports, the Shanghai Composite Index ushered in the Chinese New Year 3.74 per cent lower on the month. The Nikkei tanked 7.64 per cent, falling victim to the recent renaissance in the Japanese yen, which has gained almost 3 per cent against the dollar.
As the largest-capped Japanese companies such as Toyota and Sony rely on a weaker yen to be more competitive in the export market, the recent gains have weighed the Nikkei down.
In his last meeting as chair of the US federal open market committee, Ben Bernanke announced a further $10 billion taper, taking the total asset purchases of the Fed to $65bn per month. Despite the result coming in line with expectations, the announcement exacerbated the already sensitive emerging markets. The full effect of the reduction in liquidity seems to have kicked off the selling spree.
The run of US data has not been impressive. December’s US non-farm payroll report sprang a major surprise, coming in at a paltry 74,000 new jobs, well below the expected 196,000. And although the overall unemployment rate dropped to 6.7 per cent, it did so on the back of a shrinking labour force. The US fourth quarter GDP reading declined to 3.2 per cent, but a closer look at the figure showed some encouraging signs – personal consumption accounted for more than 50 per cent of the figure and grew to 2.26 per cent, up from 1.36 per cent in the third quarter.
Looking at the month ahead, markets will continue to remain sensitive to growth-related data but perhaps the largest driver of risk sentiment will be the resurrection of the US debt ceiling debate. The debt limit – the upper ceiling of the amount the US government can borrow – will be a topic of debate this month as the US government nears the ceiling.
Expectations are for the borrowing limit to be fully exhausted by the last week of this month, which will once again lead to heightened levels of uncertainty and an increasingly risk-averse mood. This would keep any chance of gains in equities and commodities at a minimum, which will affect the dollar and US treasuries in the high-risk environment.
Gaurav Kashyap is the head of futures at Alpari Middle East
