In the first half of 2020, lockdowns pervaded in much of the Western World. Despite the cause for economic concern in the world’s most developed economies, there was also cause for optimism with a new vaccine that promised to provide a conclusive end to the pandemic approved by one regulator or another seemingly every week. This created interesting dynamics in markets where monetary support and economic optimism mixed with visibly beleaguered economies to leave markets hesitant over G10 currencies. Instead, seeing the light at the end of the tunnel and having taken a battering during the previous 9 months of the pandemic, it was emerging market currencies that found themselves in a position to gain strength. Not only did emerging market currencies outperform during the first half of 2021 as a result of the mixed signals coming from developed market currencies, but such emerging markets also had the monetary capacity to begin to normalise policy. It was this policy shift that accommodated moves such as the rally of more than 15 percent in the Brazilian Real versus the US Dollar between March and June this year.
Rate hikes within emerging markets (such as the 325 basis points that Brazil has hiked by since the start of the year) have only been possible and had the effect they have had due to the stagnation in US policy and market expectations therein. Despite the Federal Reserve having managed to kick the can further down the road before raising policy, a definitive shift in US Monetary Policy has now taken place with markets told to expect tapering. Rising US rates deteriorates the appeal of emerging market currencies, undermining the demand generated for such currencies accrued during their own hiking cycles earlier this year. The expectation of policy tightening from the Fed too has and will crowd out the expectations and ability of emerging markets to continue to normalise policy. In FX forwards for example, at the end of June markets were pricing in 1.3% worth of rate hikes in Russia before the end of the year. Today, largely thanks to the Fed’s change of tone, that stands at just 0.5%. Since June too, under similar circumstances, the Brazilian Real is down 4.5%.
The weakness of Emerging market currencies is widespread. Their weakness should not, across the board, allow them to reach the distressed lows of during the first wave of the Covid-19 pandemic. However, given that most EM currencies have recovered all if not more than their post-March 2020 fall, present valuations could allow moderate further weakness.
Discussion and Analysis by Charles Porter
Click Here to Subscribe to the SGM-FX Newsletter
Related Insights
Morning Brief – British Pound
Humphrey Percy
Wed 8 Mar 2023
British Pound In itself not really a story but when a Member of the Bank of England’s Monetary Policy Committee opines on the UK currency, the market reacts. Yesterday it was the statement that if investors had not fully priced in the likelihood of further interest rate rises from both the Federal Reserve and the […]
Morning Brief – Bank of England
Humphrey Percy
Wed 22 Mar 2023
Bank of England The UK’s Monetary Policy Committee will pronounce tomorrow and uppermost in their minds will be the UK Inflation release which came out first thing this morning. Because it is higher at 10.4% rather than significantly lower than last month’s annualised 10.1%, not only does the Bank of England have more egg on […]
Morning Brief – Big Week
Humphrey Percy
Mon 20 Mar 2023
Big Week With news about the arranged marriage of Credit Suisse to UBS announced on Sunday night following the bank’s CHF 50 billion liquidity line injection last week, repercussions from the failures of SVB and Signature Bank and fears for First Republic Bank despite a USD 30 billion multi bank rescue, expectations for a 50 […]
