Emerging markets record $470bn stock wipeout

Expectations of a rally in Chinese markets and outperformance over developed markets have not panned out

The Shanghai skyline. An improvement in Chinese industrial profits has boosted bets for the start of a new earnings cycle. Bloomberg

Emerging markets ended a volatile quarter with China’s plunging economy, spiking US yields and rising oil prices sparking the worst decline in stocks in a year.

Despite a rebound on Friday, stocks saw a $470 billion wipeout, currencies posted back-to-back quarterly losses and sovereign risk premiums hovered at a three-month high.

It’s now clear that expectations at the start of the year for a rally in Chinese markets and outperformance by emerging markets over developed markets have not panned out.

What is less clear is what the last stretch of 2023 holds, as investors assess whether the worst of bad news in those key themes is over.

China’s economy is stabilising, Brent crude prices may be peaking and a resurgent dollar stalled after reaching a 10-month high.

What’s more, weak US consumer spending data and a slower-than-expected increase in the Fed’s preferred measure of inflation have spurred hopes that US rate hikes may halt.

“The EM rates and EMFX carry trade has been derailed by the relentless move up in US rates,” Citigroup strategists including Dirk Willer wrote in a note to clients.

“With US rates trading as if they still are in a bear market, we are cautious in the short term until we see signs of US weakness.”

MSCI’s stock index rose 0.8 per cent on Friday as Chinese technology stocks came back in favour. That trimmed quarterly losses to 3.7 per cent, its worst performance in a year.

The currency gauge also ticked up on the last trading session of September, with Chile’s peso, Hungary’s forint and Thai baht leading gains. It ended the quarter 0.4 per cent lower, a second straight decline.

Mexico’s peso was supported by a hawkish tone when policymakers held interest rates steady on Thursday, feeding expectations that the country may be the last in the region to lower borrowing costs.

Colombia’s central bank also held interest rates at a quarter-century high on Friday, though economists are expecting a cut next month.

In China, where stocks have erased $1.7 trillion of shareholder wealth since early February, satellite data show an economic rebound is at last taking hold. Recent releases showing an improvement in industrial profits have boosted bets for the start of a new earnings cycle.

US labour market trends will play a key role in the Fed’s calculation of a peak rate. Resilience in employment data in the face of successive rate hikes has been one of the surprises of the year and kept inflation expectations buoyed.

While Fed policymakers left the target range for their benchmark rate unchanged, fresh quarterly projections showed 12 of the 19 officials favoured another hike in 2023.

Moves in US yields and the dollar will track developments in these two themes. Any strength in them could filter through to emerging markets as another sell-off.

But investors will hope the recent signs of exhaustion in the US asset rallies continue, sparking a fourth-quarter rebound.