EM currencies saw a roller coaster week, especially the Turkish lira, which suffered a near-freefall until the central bank was finally forced to act to shore up confidence in the lira, with the jury still out on whether the political leadership will continue to sabotage the currency’s prospects.
Questions remain on EM currencies’ revival prospects; global risk developments haven’t improved, even as the immediate pressures from a stronger US dollar and higher US yields have eased in the wake of the release of the most recent Federal Open Market Committee minutes.
EM news and views
A rocky ride for EM currencies this week, as the USD rally was largely sidelined and US yields fell after posting new highs for the cycle last week around the time we published our prior edition of this publication. The US 10-year benchmark’s recent break to new highs since 2011 has so far failed to trigger any notable meltdown in US Treasuries, and recently lower US rates have thrown a bit of a lifeline to EM currencies, many of which have bounced back from last week’s lows.
The FOMC minutes published Wednesday provided an interesting catalyst for US bond yields this week. Those minutes deepened the impression that the Fed is willing to allow inflation to run a bit hotter without triggering a further upgrade to the anticipated rate hike path. As well, the Fed is beginning to fret how it will downshift its guidance as the policy rate gets closer to acting as a brake on the recovery. The fate of the US 10-year yield around 3.00% and the forward guidance at the next FOMC meeting on June 13 are looking like two key factors affecting global risk appetite and therefore conditions for emerging market currencies from here.
Still, as we underline in our coverage of global risk appetite below, the USD and US yield situation aren’t the only drivers of risk appetite, and there has been no improvement of late in the risk backdrop.
One distinct pattern that has manifested over the last several weeks is the relative strength of some of the most commodity-linked currencies in both DM and EM, from AUD and CAD in DM to RUB, BRL, CLP, ZAR and COP among EM’s. The market seems to be taking a position on the potential for commodity inflation from here.
A rundown of specific EM currency developments:
RUB: the ruble has provided a bastion of stability in a relative volatile environment. Even as geopolitical issues rage on, we haven’t seen new conclusive evidence on how the US’ renewal of sanctions against Iran will affect global oil supplies, and Russia’s leadership has taken a bit of low profile stance on all geopolitical fronts recently. Brent crude oil touching near $80/barrel is a major support for the ruble and the Russian central bank leadership has communicated that it is interested in upgrading the priority of exchange rate stability relative to more accommodative monetary policy after the new US sanctions levied earlier this year pushed the ruble sharply lower.
TRY: the Turkish lira dominated the EM news cycle over the last week, as the virtual freefall in TRY continued and accelerated this week until finally the central bank stepped in with a 300 basis point hike to the key rate and soothing language, including from the chief source of the lira’s woes: President Erdogan, who claims that Turkey would abide the principles of global markets. Uncertainties remain, especially linked to the risks of Erdogan’s response once he has assumed the expanded powers of the new presidency on the other side of the June 24 election, still uncomfortably far away. The very day after the central bank’s emergency hike, Erdogan’s party was out circulating the party’s election platform, which touted the need to maintain single digit inflation and to reduce the burden from high interest rates. Ouch. Significant damage has already been done to the Turkish economy by this latest episode, though one salutary – or at least balancing – effect of this recent episode should be a reduced current account deficit.
CNY: no change of strategy from China, as CNY has weakened with very low beta to the strong US dollar. It it clear that CNY stability exerts a strong gravitational pull on regional currencies, as even the back and forth on whether a North Korea/US summit will take place after all has hardly raised eyebrows in the USDKRW exchange rate over the last week.
Chart: EM commodity exporters the outperformers
The chart below shows the carry-adjusted returns for a long basket of commodity exporters RUB, BRL, COP, and CLP versus a short basket of next commodity importers and current account deficit countries INR, PHP, MXN, and TRY. Just as commodity prices have risen from the lows of early 2016, the return of commodity-exporting emerging market currencies have also outperformed relative to commodity importers/current account deficit EM’s.
The fundamental case makes sense, of course, but we have long range concerns on the strength of global growth, normally something that is negative for commodity prices. If we are to see weaker growth but higher commodity prices, it would be an environment not witnessed since the 1970’s and would suggest some new highly inflationary monetary regime. Stay tuned.