War as an economic event creates winners and losers. Theories of politics and economics suggest that there’s more losers than winners (on average by mode and mean) and in most episodes of at least recent history the world suffers economic and general setback as a result of it. Some currencies are notably less pessimistic about the prospect of war. Indeed some of the most recent winning currencies of war are what you may have thought to be highly unlikely candidates. USD and its safehaven chums is a perhaps unsurprising beneficiary of conflict. Higher risk and instability in the political economy and its currency’s demand swells as balance sheets board USD liquidity. But many emerging market currencies apart from the geographically entangled Eastern European basket have also appreciated seemingly exponentially alongside the conflict and subsequent sanctions.
The logic or perhaps simple market forces boil down to the fact that the rising price of raw materials can benefit those emerging market economies involved in the export of primary goods by absorbing some of the supply and demand that normally flows through Russia. Huge surges in the price of all that is hard and shiny in the commodity market lifted ZAR given its economy’s role in the production and export of precious metals. Concerns over food production within Ukraine and Russia boosted soft commodity exporters in South America, notably Brazil and its Real. However, it seems the music for many emerging markets however has now stopped and with risk elevated on most corners of the globe, there aren’t many chairs left unoccupied.
Rising rate expectations within the Western Hemisphere have served to inject yield into what has been an otherwise unrewarding cash paradigm since the pandemic. Stated by the Bank of England’s own (admittedly hawkish) Michael Saunders yesterday, the UK’s neutral rate of interest could be 1.25% to 2.5% and he wants to get there quickly. In the US, the yield curve implies even more mature interest rate expectations comfortably in excess of 3%. As growth expectations continue to be slashed and the reward for cash in safer financial systems becomes greater, emerging markets are now on the back foot, despite the tailwind of tighter commodity markets created by Russia’s invasion of Ukraine.
Growth expectations in China have pushed the Chinese Renminbi to recent lows. Many questions surround how China and its PBoC will manage the exodus of value behind the currency in the coming weeks. For now, the weak growth prospects have undermined emerging market currencies most notably the BRL and ZAR due to the high correlation these currencies and economies typically exhibit with China.
Discussion and Analysis by Charles Porter