by Stephen Foley and James Kynge at FT.com
The world economy is locked on a course towards an emerging markets crisis and a renewed slowdown in the US, despite the Federal Reserve’s decision last week to hold off on a rise in rates, according to one of 2015’s most successful hedge fund managers.
John Burbank, whose Passport Capital has placed lucrative bets against commodities and emerging markets this year, forecast that the Fed would eventually be forced into a fourth round of quantitative easing to shore up the economy.
In an interview with the Financial Times, Mr Burbank said years of QE had caused a misallocation of capital across the world, while the end of QE last year triggered a dollar rally with consequences that were only now beginning to be realised.
“The wrong people got the capital — emerging markets countries and corporates and a lot of cyclical companies like mining and energy, particularly shale companies — and this is now a major problem for the credit markets,” he said.
Mr Burbank was speaking days after the Fed decided against raising US interest rates from their present near-zero levels, warning of “global economic and financial developments” and the damage these could do to US growth and inflation.
One of the most worrying for economists is the declining fortunes of emerging markets. These have deteriorated sharply this year following a significant slowdown in the Chinese economy, recessions in Russia and Brazil and widespread outflows of capital.
Developing world currencies have tumbled on average to their lowest levels since 2002. The Brazilian real moved to within a fraction of its all-time low on Monday, trading at R$3.9901 to the dollar — down 1.13 per cent from Friday’s close.
Emerging market GDP growth rates are set to fall to 3.6 per cent this year on average, their lowest level since the 2008/09 financial crisis, according to estimates from Oxford Economics. Industrial production is also anaemic, growing by just 2.2 per cent in the second quarter across emerging markets, the research firm added.
Such signs of distress, coupled with a potential tightening in US monetary policy, have persuaded investors to flee developing world asset classes. Net portfolio flows into emerging market equities and bonds were negative for 35 straight days until September 15, just one day short of the 36-day streak of outflows during the 2013 “taper tantrum”, according to the Institute for International Finance, an industry association.
Passport, based in San Francisco, manages $4.1bn in three main funds. Its $2.1bn Passport Global fund was up 14.6 per cent at the end of August and a smaller, more concentrated “special opportunities” fund was up 30.6 per cent. Both funds are in the top 15 best performers, year to date, according to the industry league table compiled by HSBC.
Investors were not recognising the risks, Mr Burbank said, and Passport was not pulling out of its bearish bets.
The dollar rally caused by “asynchronous QE” — the early end of money printing in the US relative to Japan and the eurozone — and the economic fallout from a slowing China guaranteed a financial crisis in emerging markets that would rebound on the US, he said.
“All of that turmoil around the world will come back and slow down capex and hiring and consumer buying in the US, and that will make the Fed realise they should be easing and not hiking,” he said.
“I think we are on the precipice of a liquidation in emerging markets, and this feels the way that the fourth quarter of 1997 felt.”