background image background image background image

FOMC holds fate of EM in its hands

Picture of John Hardy
John Hardy

Head of FX Strategy

Conditions for EM currencies have worsened further as global bond yields have rebounded after the Italian election-inspired disruption and as EM credit spreads have shown further signs of strain. The odd indicator out remains suppressed market volatility, as low volatility and strong risk appetite in developed markets rarely coincides with EM currency distress. This week’s FOMC meeting could throw a lifeline to emerging markets if the Fed slows its quantitative tightening schedule and/or loosens its commitment to the current pace of rate hikes. But this is far from a sure thing, as the Fed may be looking for more flexibility rather than trying to make the explicit dovish shift that would provide some more profound near-term relief for EMs.

EM developments over the last week

A few specific EM currency developments for the EN currencies with the widest performance swings this week:.

TRY: the Turkish lira managed a resilient performance last week after the Turkish central bank hiked the repo rate 125 basis points in a move that few anticipated. The extreme TRY carry helps to offset the strain on Turkey’s credit spread, which has worsened back toward the worst levels for the cycle even as the lira exchange rate has at least attempted a recovery. The currency weakness should begin to right the current account situation in the months ahead as well. The next critical steps for Turkey lie on the other side of the June 24 presidential election and how President Erdogan responds to the flogging the country’s exchange rate has been administered by global markets. Has he been cowed or could he reach for desperate measures? The potential is there for a full blown crisis and even default if conditions for EM worsen further and Turkey’s leadership makes the “wrong” decisions.

BRL: The Brazilian real saw a roller coaster ride over the last couple of weeks, first lurching into an ugly slide even after a paralysing strike concluded as a rising popular chorus supports military intervention and the right-wing populist Bolsonaro gained political momentum from the episode. Last Friday, however, the Brazilian central bank made a more pointed promise to deliver enough intervention to stem the flow out of the currency, and the BRL rallied to recover all of the losses over the prior week. The actual spread on Brazilian USD-denominated debt versus a US treasury counterpart has not improved, however, as we point out below, so the sustainability of the real’s comeback is still an open question as the country faces a long wait until October elections and the new angle of (also an echo of Brazil’s past) right-wing populism and the military in the mix.

Chart: We highlight a quartet of the EM currencies below for which credit spreads on USD denominated debt has worsened again recently to, or close to, cycle wides. Without improvement in the appetite for EM assets, the currencies will remain under pressure and the recent volatility may have also seen hedging demand for existing portfolio exposures picking up. All four of the countries charted below have sufficiently large external debt loads that point to the risk of the situation getting worse if authorities can’t improve foreign investor confidence. Note the remarkable situation in South Africa as well, where the specific USD bond yield spread is almost back to where it was when the currency was under the most pressure during the final portion of former President Zuma’s rule late last year.

EM forex chart

MXN. Since our last update on the first of the month, MXN has come under further significant pressure not only from general strains on EM, but also as Mexico took the step of announcing its own tariffs on US pork and other products, a move guaranteed to elicit a pointed response from the Trump administration – though things could go quiet on the trade front until after the left populist Obrador (assuming overwhelming polling leads are correct) assumes office and makes his bargaining position clear. There is a strong domestic focus in Orbrador’s platform that has the market concerned for the fiscal and current account implications. We are in the countdown phase to the July 1 election at which populist Obrador is widely expected to gain a strong mandate.

IDR: formerly a “fragile five” member (together with India, Turkey, Brazil and South Africa), Indonesia has unleashed the most aggressive official response to the general malaise impacting emerging markets. The central bank faces an easier task than elsewhere in defending the currency as the country’s external debt load is somewhat lower than many of the more fragile EM peers at around 33% of GDP, the country has a large export exposure to China and that country’s strong currency. The central bank and its new governor Warjiyo have countered recent currency weakness with policy tightening and stout promises to do more if necessary to stay ahead of the problem.

Chart: Global Risk Index – odd combination of risk off with pockets of complacency

The Global Risk indicator remains in risk off territory, with a very different twist from the episode that inaugurated the long run in risk averse territory back in early February. Back then, sudden violent market volatility was the focus, with few signs of strain in credit spreads and other indicators. This time around, the situation is the reverse, though spreads in both credit and EM credit are still quite far from where they were when the brutal USD strengthening rode roughshod over EM back in late 2014 and for most of 2015 as well.

EM forex chart
Source: Saxo Bank

EM Currency Outlook: The FOMC could bail out EM for the short to medium term, but will it?

The current hopes for an EM recovery rest in US Federal Reserve’s hands and this Wednesday’s FOMC meeting is the marquee event for a change of pace that could provide EM at least a window of relief for some time. The argument goes that the Fed could shift the current quantitative tightening schedule due to the blizzard of treasury issuance. The Fed could do so without losing too much credibility as the Trump tax reform was passed well after the Fed could ever have anticipated. As well, Fed Chairman Powell has indicated a preference for policy flexibility, especially now that the Fed funds rate will soon reach a longer-term neutral rate from its long stay in the accommodative zone. Leaving the QT on some sort of automatic tightening clock makes little sense in that regard, especially as the QT schedule is set to reach a pace of shrinking the Fed’s balance sheet by some $40 billion a month as of July 1 or nearly half of the pace of the Fed’s enormous QE3 purchases back in the late 2012 to 2013 period. 

It’s possible, then, that the Federal Open Market Committee gives the EM a reprieve for the coming few weeks or even a quarter, but ultimately this move may be seen as the Fed looking for more flexibility rather than waxing dovish and late cycle concerns still have us looking for further strain on EM and deeper discounts before expressing interest in exposure to EM currencies. At the same time, a number of Fed members have expressed concern that the flattening and now nearly flat US yield curve represents a hurdle for raising short-term interest rates much further, so how the Fed deals with further policy rate adjustments when the term premium is vanishing is another open question. At least one prominent Fed member, Lael Brainard on the Fed’s Board of Governors, however, seems unperturbed  by the prospects of the yield curve flattening and perhaps even inverting. Regardless, if this or coming FOMC meetings and a guidance shift from the Fed fail to cap US yields, EM assets and currencies may not even receive a near-term reprieve.

EM currency performance: Recent and longer term, carry adjusted

Chart: the weekly spot and 1-month carry-adjusted EM FX returns vs. USD.  Individual short-term performance metrics are misleading over the last week for the Brazilian real, which saw a collapse and then even larger recovery in the space of a week – while it is still down for the month. The worst performer over the last week and month has been the South African rand, where credit spreads have worsened after an ugly GDP decline in Q1 was reported last week. 

EM forex chart
Source: Saxo Bank

Chart: 3-month and 12-month carry-adjusted EM FX returns vs. USD 

The four weakest links over the last four months – TRY, BRL, ZAR and MXN are our focus in the credit spread chart. In Asia, China continues to provide an anchor for most other Asian currencies with its very low beta moves to the general USD direction and declared strong CNY policy. 

EM forex chart
Source: Saxo Bank


The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (
Full disclaimer (
Full disclaimer (

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15

Contact Saxo

Select region


Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.