FX Update: EM focus: running out of steam?

Forex 5 minutes to read
John Hardy

Head of FX Strategy, Saxo Bank Group

Summary:  Given the weak US dollar of late, EM currencies have naturally benefitted a great deal over the last month. The pace of gains has moderated over the last week or more ahead of the important FOMC meeting this Wednesday. The FX Update for today focuses on EM currency performance and perspectives for the New Year.


EM performance – recently and over the past year
The US dollar and global risk appetite are usually the two most important factors for EM currency performance broadly, and often dollar direction and risk appetite are strongly negatively correlated and somewhat the same thing. Still, there are inevitably many moving parts and idiosyncratic stories driving relative individual EM currency performance, even if the majority of EM currencies swim in the same direction over medium-term and longer time frames.

Chart: Short-term EM currency performance
In the short term performance charts, we note that the Chinese yuan and Asian EM currencies most firmly in its orbit (KRW, TWD, MYR, THB) have seen their performance cool notably over the last week or more, while still up over the last the one-month against a struggling US dollar. Note that USDCNY and UDSKRW have an r-squared of over 0.92 for the last 200 trading days and, meaning that the Korean Won is more or less thoroughly in the CNY’s orbit – which makes sense given the country has a nearly 11% weighting in the official CNY reference basket – fully half of that for the US dollar for an economy a fraction of the size (and a currency with orders of magnitude less liquidity). The strongest performers over the last month are those currencies mostly firmly linked to the hopeful narrative for 2021, that a post-Covid-19 vaccine recovery on its way and will see a sizable rebound  in demand, with still generous monetary policies possibly driving inflation, particularly in the  commodities sector. Note that all of the four strongest performers over the last month are closely linked with specific commodities, or baskets of commodities in Brazil’s case (soybeans, coffee and iron ore). On the weak side, the Turkish lira is a victim of the time window of 1-month, as the currency topped out in mid-November after a huge surge from the October lows before Erdogan announced he would take the “bitter” medicine needed of strong rate hikes to slow the rapid devaluation of the currency.

Source: Saxo Group and Bloomberg

Chart: Longer-term EM currency performance
This chart shows where the longer-term underperformers simply can’t hide. Brazil has been the 12-month worst performer as it struggled with the Covid-19 pandemic and the collapse in prices for its important commodities this spring like oil and iron ore, not to mention the slashing of its Selic policy rate by some 250 basis points this year. As note above, however, it has surged strongly over the last month or more. Still rather surprising that its carry-inclusive downside exceeded that of the very weak Turkish lira. The majority have strengthened versus the US dollar over the last 12 months.

Source: Saxo Group and Bloomberg

Chart: Global Risk Indicator
Our Global Risk Indicator is still strongly in the green but has faded somewhat, in part on a pickup in volatility measures and as credit spreads have largely stopped falling (though not yet rising anywhere by any meaningful amount). Timing-wise, if the FOMC meeting this week – more below on that – fails to support a further sell-off in the US dollar for a while, the market may be a bit out over its skis and due for a correction in coming weeks, though if a reflationary recovery is what we get in 2021, and one with a weaker USD (which is really a necessary pre-condition for a reflationary outlook anyway), then EM currencies should put in a strong 2021.

Saxo Group and Bloomberg

Watching the FOMC and end-of-year.
The FOMC meeting this week could prove a non-event or one that moves the US dollar sharply in either direction. If the Fed entirely fails to deliver anything at the meeting, this could be seen as hawkish and as a sign that the Fed is a bit concerned that it may have over-eased financial conditions and that this could bring instability in financial markets, preferring instead to hammer on the message that it has done its part with monetary policy to keep markets orderly and rates low, now it is time for fiscal policy to take over. If this is the Fed’s stance, I suspect the message would be delivered extremely gently and clouded in weak language.

If, on the other hand, the Fed indicates that its level of concern has picked up notably on some of the recent weakness in employment-related numbers, it could signal that it may shift its mix of purchases toward the longer maturity treasuries after yields have backed up a bit at the longer end of the US yield curve. Some measure of this seem to be the consensus expectation. A hybrid of these two is also possible – or a signaling that a future policy of shifting purchases will be implemented if long rates spike too quickly and the jobs data continue to bog down. We’re not sure how reactive the market is to all of this, but given the rather aggressive USD move in places, the FOMC meeting will need to bring material signals that the Fed will provide more easing or the USD could risk backing up for a time. And EM will always prefer an easy Fed and react poorly to any shade of a “hawkish” surprise. On a different note, end-of-year factors could be in play for the final couple of weeks of this year that bring unpredictable and unattributable swings in markets.

Disclaimer

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 (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Support Centre
For existing clients, please click here to request support via the Support Centre.

Have a question about our products, platforms or services? Visit the Support Centre to find answers for our most frequently asked questions. If you are still unable to locate an answer to your question, you will also find contact details for your local Saxo office to speak with a representative.

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. 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
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.