Over the last 12 months, most market participants have focused intently on the Federal Reserve (Fed) beginning to wind down the asset purchase programs enacted during the global financial crisis. However, after one of the worst years for emerging market (EM) assets since 2008 and a tumultuous start to 2014, EM central banks are seeking to bolster their own credibility and help restore order in markets that have been all too prone to overshooting on both the up- and the downside. While risks to the underlying EM thesis remain, we are encouraged by steps taken by many central banks in the face of continued currency pressure.
Policy Making Doesn’t Occur in a Vacuum
In much the same way as the Fed has signaled that changes in policy will be data dependent, so too are changes to monetary policy in emerging markets. So far in 2014, four EM central banks have sought to raise short-term interest rates to achieve their policy objectives. However, the motivations for these policy shifts differ greatly. EM central bankers are being asked not only to react to external factors such as changes in U.S. policy, but also to help manage domestic interests. In some respects, this hits the very core of a major thesis of WisdomTree’s for 2014: continued differentiation across emerging markets. While this discussion will be expanded in greater detail in an upcoming blog post, painting emerging markets with too broad a brush may cause investors to miss out in the second half of the year. The remainder of this discussion will focus on the specific motivations for the changes in monetary policy in Turkey, South Africa, India and Brazil and what we see as potential opportunities in 2014.
Highest Policy Rates in EM
In perhaps the biggest headline to come out of the emerging markets in recent weeks, the Central Bank of the Republic of Turkey (CBRT) raised all three of its main policy rates by significant margins.1 In the announcement, investors were instructed to focus on the one-week rate—which was raised from 4.5% to 10%— as the new policy benchmark going forward. The CBRT was forced to react definitively after an earlier policy meeting disappointed investors and the lira plunged. We remain cautious about the underlying fundamentals in Turkey but believe that the central bank’s policy change must be given time before we can fully understand its effects. While many economists believe that the CBRT had previously succumbed to political pressures, we see the most recent move as a significant signal that it is committed to a more independent approach going forward. As a result of this policy change, interest rates in Turkey are now the second highest in the emerging markets that WisdomTree monitors. Even though we believe volatility will undoubtedly continue to persist, we are somewhat more constructive on the emerging markets as investors assess whether broad-based selling may have overshot. Since the central bank announced its bold 5.5% rate hike, the Turkish lira is the single best-performing EM currency (as of February 7).