EM Currency Outlook: Concern level for EM has shifted a couple of notches higher
Our chief concerns for the EM FX outlook remain the weak global risk appetite backdrop. But as well, EM currencies have disappointed by failing to stage a more significant recovery after the solid adjustment lower in Federal Reserve rate expectations. We don’t think that the Powell Fed is trying to wax dovish in recent language shifts promoting the “symmetry” of response around the inflation target. Rather, we suspect that this is an attempt to shake the sense that the Fed is “pre-committed” to any course of action now that the 2 % inflation target has come into view, giving it more flexibility to respond either way based on incoming data.
Still, the recent Federal Open Market Committee minutes do give the sense that the bar is higher for the Fed to adjust rate expectations higher for the near term. So the risk of higher US yields may have faded for now as an EM headwind, but lower rates might not be particularly supportive if these are owing to weak US data.
Of course, it is difficult to determine how much of the recent bout of weakness in EM was simply collateral damage from the rogue wave that washed over EU peripheral sovereign debt markets over the last week – but we’re not entirely convinced that it is the chief contributor to ongoing pressure on global risk appetite that keeps our caution level on exposure to EM assets high. If USD strength fades further from here with or without a drop in US yields as the global growth outlook turns higher again, there may be a window of opportunity for EM exposure, but we’re still sitting on the sidelines for now.
EM currency performance: Recent and longer-term, carry-adjusted
Chart: the weekly spot and one-month carry-adjusted EM FX returns versus USD
A Latin American duo scraping the bottom of the rankings this week as MXN struggles with Trump tantrums and the onrushing July 1 election and BRL has been buffeted by strikes and a much longer wait for October elections and the urgent need for fiscal reform.