EM and the Unknown

EM and the Unknown

It is a simple enough proposition.

During May-December 2013 the world faced a particularly challenging Unknown linked to the start of Fed policy normalisation (ending bond purchases followed by raising US interest rates to more normal levels) after a long period of historically unprecedented unconventional policy actions, increasingly giving the impression of being left on a very precarious limb without an easy way back.

The uncertainty encountered in the process was killing. Put into this condition, markets pummeled (repriced) especially risky propositions most, for the simple reason these offered the greatest uncertainty as to ultimate outcomes.

The most exposed were the so-called Emerging Market (EM) Fragiles, so designated by a few simple metrics. These countries (Brazil, India, Indonesia Turkey, South Africa) in the process became repricing (selling) propositions.

Fast forward to today, or rather recent months.

The hurdle of the Fed starting bond tapering was taken and successfully cleared. Markets gained experience and insight in the process and associated risks. The unknown made way for greater certainty of knowing one's way around this obstacle course called Fed normalisation from exceptional unconventional policy stances.

Not total certainty (ever), but a calculated kind of certainty. We are handling this without major mishap. We can handle this. Far from certain yet about the final playout, yet having made great strides in getting a grip on things.

This translated itself into less market anxiety regarding the most exposed, at risk assets, the still infamous EM Fragiles, except regarding them there had also been a discovery process.

With these EMs vigorously contesting these derogatory depictions, and also adjusting their own policies and conditions, even if sometimes only still to a minor degree, a better handle was also achieved on them, as much due to the EM pushback as a progressive reassessment, even if often still far from sympathetic.

Yes, these countries were exposed and risky, but more robust and resilient, each to their own extent, more than allowed so far? Imagination? Some of it perhaps, but not all of it.

A sudden sharpening awareness of a looming Unknown can be most disturbing and create uncertainty that invites fleeing (repricing risk). Once the Unknown takes shape, and more is learned about it, it becomes more familiar and less terrifying, and can be placed more easily. In the process the uncertainty about what is being faced wanes, and the risk premiums ease.

Everything being relative.

The Great Unknown at issue is still the Fed policy normalisation after a period of historically exceptional unconvential actions, the full reach and consequences of which are still to be learned.

And as if one horror story to digest is not enough, China's modern transition challenges have also come into greater focus this past year, offering a similar quality Big Unknown to global markets to be digested alongside the US one.

But here, too, learning curve applies as the problems and risks are lived through and a better grip is acquired with each passing moment, regarding financial frailty and economic adjustment.

The verdict? We will live, for now, even as minor regional sideshows, like Ukraine, and geopolitical ones, like Russia and the West, play, too.

Technically, the next installment in the Fed policy normalisation (picking the moment to start raising interest rates and seeing it through to normality) will be as momentous, if not more so, than the first, bond tapering installment.

But the first terror is gone? And it is always the worst?

What is coming into view is much more conventional, assessing growth and output and inflation gaps, and judging when rates need to be increased, with the guiding mantra remaining throughout that it is likely to remain slow and long, given that it is and remains a gradual repair and recuperation from a Great Crisis.

Not for everyone but for enough participants to calm the waters.

This doesn't mean EM Fragiles (sorry for insisting on the term but they ARE weak and everything is relative) are out of the woods yet.

Merely that the second, main act is upon us, probably within the year, yet the terror seems to be already much less,  the unknown more manageable, the uncertainty less killing, at least when going by appearances.

The whole US (and global) rate adjustment still lies ahead of us, Easter 2015-2017/2018, but EM Fragiles may find themselves not pummeled to the same degree as in 2013. Still more repricing, but possibly more gently applied?

More Rand weakness and higher bond yields, yet spread out and not imposed with such shock treatment as seen in concentrated fashion last year?

We could be so lucky?