Pain Is Back On for Emerging Market Currencies

Pain Is Back On for Emerging Market Currencies

Decent returns in September are getting crushed by the dollar and domestic ills.

It was all looking so promising.

In September central banks in some key emerging markets were, for once, mostly in tune. Controlling inflation and offering stability were the order of the day. Currencies responded well, offering a positive return and a respite during a tough year. But that good performance is coming undone.

The Turkish central bank led the way with a massive 625 basis point hike in its key interest rate. A surprise 25 basis point increase from Russia proved policy makers’ determination to contain prices. And while the South African Reserve Bank kept rates on hold, officials look set to tighten when they next meet in November.
But that was all last month, and the dollar rules once again. The U.S. economy is powering ahead, so the momentum behind the greenback looks substantial. 

King Dollar

A strengthening greenback heaps pressure onto emerging market currencies

U.S. unemployment, at 3.7 percent, is the lowest since 1969. Ten-year Treasury yields closed Friday at 3.23 percent, the highest since 2011.

Building Up Steam

The steady gains in U.S. wages is helping drive up interest rates

And the upward march in oil prices is relentless – they’ve gained 25 percent so far this year. 

Pain Trade for Hydrocarbon Importers

Emerging market countries that are net oil and gas importers will feel the strain of pricier crude

These are powerful forces. And, compounding the problem, the domestic issues afflicting the some of these nations are getting worse.

Turkey's September inflation data showed that the central bank has acted too late, and price gains are out of control. The core rate is at a record 24 percent, and producer prices are nearly double that. Policy makers will have to tighten further if they are to fulfill their mandate, it’s an open question whether President Recep Tayyip Erdogan will allow it. Meanwhile, the economy is imploding. 

Russia’s spying and hacking raise the risk of further sanctions, particularly from the European Union. International condemnation of its activities abroad is increasingly offsetting the substantial benefit it should be receiving as a major oil exporter, a source of support many emerging economies don’t have.

The South African rand’s slump partly reflects investor fears of fiscal slippage at the medium-term budget statement on Oct. 24. It worsened Monday after Business Day reported that Finance Minister Nhlanhla Nene has asked to resign after he disclosed links to the Gupta family, who have been implicated in a corruption scandal involving former President Jacob Zuma.

Disappointingly, not all policymakers are getting the message. India's central bank surprised on Friday by leaving rates unchanged in the face of investor expectations for an increase to support the currency and tame persistently high core inflation. The rupee sank to a record low against the dollar as a result. 

So, bond yields are rising across emerging markets as a whole.

Rising Yields

Local currency emerging market bond yields are at the highest for nearly four years

Not all countries are looking so grim this month. Argentina’s peso is the best performer among major emerging markets so far, now that the International Monetary Fund has improved terms on its bailout. In second place is Brazil, but the outlook for the real is difficult to call since the country is in the midst of a Presidential election that could produce a substantial change of policy direction. 

Otherwise, it is hard to see how the weakest emerging market currencies this year can recover their glory days of September unless there is significant improvement in resolving domestic problems. And even then, with the U.S. economy roaring away, it’ll be a stretch.

 

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