Conditions for EM currencies have deteriorated further as EM credit spreads have worsened again and the threat of trade wars has also jolted formerly resilient Asian exporting economies like Thailand and South Korea. The USD strength is no help, given the trillions in USD-denominated debt across emerging markets. We’re not hopeful that EM currencies are set for a sustained rebound any time soon and weakness is in fact broadening badly on the trade war theme. For the week ahead, the weakest link of all in major EM currencies, the Turkish lira, faces a critical test at the election this Sunday.
EM developments over the last week
A few specific EM currency developments for the EM currencies with the widest performance swings this week:
TRY: The Turkish lira weakened further even after the recent central bank move to defend the currency with an additional rate hike. The next week presents a major test for the currency on elections this Sunday, June 24. Has Erdogan’s popularity suffered enough with the recent currency turmoil to hand a more unified opposition the victory? The odds looks slim, but if the Ince-led opposition does prevail, the lira would likely see a one-off, massive recovery gap. Whether further TRY weakness is possible under an Erdogan victory, on the other hand, would largely depend on Erdogan’s policy steps, given prior signals that he would like to interfere with central bank policy. Just over this last week Erdogan indicated he would “deal with interest rates”. Not helpful. Credit spreads have widened perilously for Turkey’s USD-denominated debt in recent weeks and have worsened further over the last week.
BRL: The Brazilian real has stabilised since the Brazilian central bank promised to take the necessary steps to stem currency weakness via intervention in currency swaps, choosing not to reach for the interest rate level to bolster confidence in the currency as the economy limps along with 1.2% growth as of Q1, having emerged from recession just last year. Brazil is very reliant on exports and the threat of a trade war is a two-edged sword for the country as trade wars are bad for growth but could be very good for Brazil large soybean crop as prices for export to China could rise dramatically if China places high tariffs on its largest supplier, the US. Meanwhile, nothing has improved on Brazil’s political front, where the necessity of pension reform remains with no solution in sight and a long wait until the October election. As well, Brazil risks further aggravating its fiscal shortfalls by reinstating fuel subsidies to end the recent strikes.
Chart: Credit Spreads for Turkey, South Africa, Mexico and Brazil. Here we show the main driver of pressure across emerging market currencies, the widening of credit spreads that has shown no mercy for Turkey, Brazil and South Africa, even if the action in the actual exchange rates has been a bit more sideways than the spreads in some cases as authorities intervene. The credit spread for Mexico actually improved slightly over the last week, allowing a modest bounce for MXN, but the July 1 election looms there.