Federal Reserve Building Washington DC
The US Federal Reserve’s decision to pump trillions into the equities market triggered the flight of a portion of such easy liquidity into emerging markets. The results were predictable-emerging markets boomed. We’re talking appreciations of 25% and beyond. Now that the Fed has stopped quantitative easing only to have the anti-deflation baton picked up by the European Central Bank, it is increasingly becoming clear that emerging markets may be ripe for an exit. In fact, based on some key factors, it might be a good idea to start considering short positions in emerging markets. You can take short positions in the form of currency bets or equities bets.
Troubling signals ahead
One of the broadest indicators of a reversal in the fortunes of emerging market equities is the MSCI Emerging Markets Index. It declined 5% each year for the past two years. Moreover, Bloomberg’s emerging market currency tracking figures show that, on average, emerging market currencies have lost 20% of their value against the US dollar. If all this wasn’t bad enough, the IMF has cut its growth forecast. What’s causing the decline in the fortunes of emerging markets as a whole? Well, part of it is regional: China has been slowing down, Brazil is caught in the grips of rising inflation tied to lower GDP growth, and Russia has its Ukraine issues. A lot of the weakness is due to a slower overall global economy. All this hasn’t escaped the attention of short traders. Short positions are mounting against emerging market bonds. It appears this bet is grounded in the very real possibility of capital flight if the US Federal Reserve announces increased interest rates.