Key News

• The highest inflation-adjusted yields in 15 years are helping provide the Treasury with record demand at auctions as the U.S. prepares to sell $115 billion of notes this week. (Bloomberg)

Quotable

“What if everything is an illusion and nothing exists? In that case, I definitely overpaid for my carpet.”

                             Woody Allen

FX Trading - Emerging markets soaring...overshoot?
Emerging markets continue to fly.  Many for good reason I suspect.  The iShares MSCI Emerging Stock Index has rebounded 50% from its low back in November last year.

However, emerging markets tend to move in unison, driven together by the key global macro rationales of liquidity, risk appetite, and commodities demand.  But not all emerging markets are alike. 

Russia and South Africa coming rushing to mind as areas that have a seemingly decent probability of imploding as economic risks feed growing political risk.  But you wouldn’t know it by looking at their respective currencies in relation to the US dollar. 

The Russian Ruble – US$ is up about 18% since bottoming in February…

….while the South African Rand – US dollar has jumped a whopping 49% since last October.

Both Russia and South Africa are being hit hard by the plunge in global demand. 

Russian GDP plunged 10% in the first half of 2009.  Its companies and once might oligarchs are laden with debt.  Reserves are dwindling as the government tries to prop up the economy.  Non-performing loans on bank books continue to rise, thus bank lending is still falling despite Putin’s edict to open the loan flood gates.  If a big rebound in the demand for “stuff”—which is the only thing that sustains the Russian economy—doesn’t come soon, the probability of implosion rises accordingly.

South Africa is mired in recession and their current account gap is widening fast—it reached 7% of GDP in the first quarter of 2009, up from 5.8% in the Q4 ’08 as demand for real “stuff” has fallen.  But even more dangerous is the rising political tension, as President Zuma’s ANC supporters are increasingly unhappy.  Mr. Zuma buoyed expectations dramatically for poor South Africans during his recent Presidential campaign—but he hasn’t delivered the goodies.  “There is an ugly, unpredictable mood among South African’s poor.  Karen Heese, an analyst with Municipal IQ, a Johannesburg-based research company, said that, while protests during the recent years have tended to focus on specific problems such as housing or water, the recent series of actions has been ‘more generalized and more violent.’”

Maybe the market is discounting that things will improve for both countries.  Or maybe what we see in the currencies of Russia and South Africa is simply a self-reinforcing trend in price driven by rationales lacking validity—the raw material of classic overshoot in currency markets.