A week ago, the Fed delayed raising interest rates, highlighting officials’ concern about fragile global growth.
The outlook from China isn’t improving, either, with growth at its slowest pace in more than two decades. Manufacturing activity released in the week fell to its weakest level in over six years, adding more evidence that economies reliant on Chinese demand are in a tight spot and need to look for new avenues of growth.
These twin challenges have exacerbated the fall of emerging-market currencies and put a spotlight on the shakier of these economies. At the same time, central banks with dwindling foreign-exchange reserves are running out of options. Growth forecasts are being slashed and fiscal deficits are widening.
“We’re not ready to be big buyers, or call a bottom, in emerging-market currencies,” said David Rolley, co-head of global fixed income at Loomis, Sayles & Co., which oversees $242 billion. “In EM, too many economies make a living in commodities, which have been soft. We’d need to see a catalyst for global growth first. Right now, it’s hard to build a case that there’s any speeding up anywhere.”
In Brazil, where the real is the worst performer of any major global currency so far this year, the central bank forecast a far deeper recession and Alexandre Tombini, its head, made a surprise announcement that Brazil could dip into its $371 billion in reserves to stem the currency’s bleeding.
On Friday, the central bank announced another auction of currency-swap contracts to calm the country’s foreign-exchange market. The bank has auctioned off the swap contracts, which offer businesses a way to hedge their exposure to dollars, and dollar repurchase agreements, on multiple occasions in recent weeks as the real has plunged.
The Brazilian real strengthened against the dollar on Thursday but weakened Friday after the central-bank intervention. Late in New York, the real was at 3.9745 reais to the dollar, according to Tullett Prebon, versus 3.9507 Thursday.
The Asian Development Bank this past week cut growth forecasts for emerging Asia for this year and next year, while the Organization for Economic Cooperation and Development a week earlier said the outlook for emerging-market economies had worsened, further casting doubt on global growth prospects.
Emerging markets largely weathered the global financial crisis with strong fiscal balances, a lesson learned after the late 1990s. But that buffer is thinning, exposing the shortcomings of economic reform and other deep-seated barriers to growth. Political volatility in countries such as Turkey, Malaysia and Brazil adds to the instability.
“Markets are in the process of pricing in weaker [economic] fundamentals than what [they] have been used to for the last couple of decades and are in the process of overshooting,” said David Oliver, an emerging-markets debt portfolio manager at Stone Harbor Investment Partners. “How much further it goes is hard to say.”
Fiscal deficits—when governments spend more than they bring in—as a percentage of gross domestic product are becoming larger and are forecast to be at their widest since 2009 by Barclays analysts. The problem with weakening government finances amid weak growth and depreciating currencies is that it has “led to a marked rise in emerging-market public debt,” the analysts wrote in a note Friday.
The rising debt burden comes as foreign-exchange reserves, often seen as an economic buffer, have started to deteriorate as central banks attempt to prop up their currencies, a reversal from years of stockpiling. That means their ability to service short-term debt is also falling. Borrowing costs have also been rising for emerging markets
The high likelihood that emerging-market currencies will continue to plummet against the U.S. dollar has made these currencies some of the most heavily traded assets in financial markets, investors say. Analysts are recommending that investors buy baskets of credit default swaps to bet on unrelenting decline in emerging-market bonds.
Like Mr. Oliver, other investors are beginning to look for value in assets that have suffered hefty losses, such as quasi-sovereign bonds in Brazil or bonds of commodities companies in South America.
Mr. Oliver said it could pay for investors to look for opportunities at this time, “even as dire as the fundamentals might look.”
—James Ramage contributed to this article.
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