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Brazil Selloff Feeds Global Emerging-Markets Retreat -- Update

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06/07/2018 | 11:02pm CEST

By Ira Iosebashvili

A sharp drop in Brazilian stocks and its currency stoked a decline in emerging-market assets Thursday, as concerns over trade tensions and a rising dollar reverberated around the world.

Brazil's Bovespa index fell 3% to its lowest level of the year and the dollar rose 1.4% against the Brazilian real to 3.9076, its highest value since early 2016. A host of other emerging markets, including South Africa, Mexico and Russia also notched big drops in their stocks or currencies.

A rallying dollar and rising U.S. bond yields have ramped up pressures in emerging markets this year, magnifying investors' concerns about some countries' economic shortcomings and prompting them to punish the assets of those deemed vulnerable. Dollar strength is a danger for some countries because it weakens their currencies and makes it more difficult to service dollar-denominated debt, while higher U.S. rates dim the allure of foreign assets.

Although past blowups in developing countries have largely been contained in recent years, Thursday's broad-based selloff shows that investors have become more wary of emerging markets as a whole, following sharp selloffs in Argentina and Turkey last month, analysts said.

Negative sentiment is "spreading to places that are not considered to be as vulnerable," said Ilya Gofshteyn, a strategist with Standard Chartered Bank. "It's looking pretty ugly across the board."

In Brazil's case, investors have become increasingly worried about recent labor strikes, shaky economic growth and a presidential election later this year, analysts said.

Exacerbating those worries are Brazil's interest rates, which stand near historic lows after a long series of cuts by the country's central bank. While low rates help boost growth, they also make it easier for investors to bet against a country's assets.

Brazil's central bank left rates unchanged for the first time in 19 months in May, citing concerns about global economic turbulence weakening the local currency. Other central banks with weak currencies, such as Argentina and Turkey, have rushed to jack up interest rates in recent weeks.

For Brazil, "the protectiveness of very high interest rates is not in evidence now," said Alan Ruskin, macro strategist at Deutsche Bank.

Trade tensions between the U.S. and its partners also weighed on emerging markets, which are sensitive to potential fluctuations in global growth. President Donald Trump, heading into this weekend's meeting of the Group of Seven industrialized nations, has signaled his intention to continue pursuing an aggressive trade agenda.

The Turkish lira was one of the few emerging-market currencies to strengthen Thursday, after Turkey's central bank unexpectedly raised interest rates by 125 basis points.

Late Thursday in New York, the dollar fell 1.6% against the Turkish lira to 4.4844. The Borsa Istanbul 100, Turkey's main stock exchange, rose 2%.

Rising consumer prices were a key factor behind the move, the central bank said in a statement. It also pledged to retain a hawkish view on monetary policy. Turkey's annual consumer-price index jumped to 12.15% in May, its highest level since November.

The lira's weakness was another important factor in the central bank's decision, analysts said. Turkey's currency has lost more than 20% against the dollar this year, weighed down by worries over Turkey's external debt and the independence of its central bank. The country's president, Recep Tayyip Erdogan, has in the past spoken out against tighter monetary policy.

Investors are also closely watching Turkish presidential elections, which are slated for June 24.

"The currency's drop was getting out-of-control and the central bank knew it had to act," said Win Thin, a strategist at Brown Brothers Harriman. "In this bearish environment, they may have not done enough yet."

--Daniel Kruger contributed to this article.

Write to Ira Iosebashvili at ira.iosebashvili@wsj.com

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