WASHINGTON: Emerging-market currencies hit by a hawkish Federal Reserve (Fed) could soon regain their record run against the dollar on expectations that developing central banks may outpace their US counterpart in policy tightening.
The currencies of Brazil, Russia, the Czech Republic, South Africa and Hungary – countries that delivered multiple rate hikes or are expected to do so soon - are retaining quarterly gains and outperforming peers. More may join their ranks, with tightening expectations growing for countries including Chile and South Africa as economic activity and inflation roar back from a pandemic-driven slump.
In comparison, the Fed has signalled it’s likely to lift interest rates only in 2023. While recent dollar gains have stalled the momentum in emerging-market currencies, that picture could change once the greenback’s support from positioning shifts fades, according to Bank of Singapore Ltd and JPMorgan Asset Management.
“Emerging-market central banks are set to begin raising interest rates well before the Fed,” said Mansoor Mohi–uddin, chief economist at Bank of Singapore Ltd. “Over the summer, lower volatility may induce investors to put on seasonal carry trades again to the benefit of higher yielding emerging-market currencies.”
US financial conditions are closely correlated with demand for risk assets, including emerging-market stocks and currencies. While taper talk has been the focus of investors’ concerns, they should be watching for signs of tightening financial conditions, which could trigger a selloff, according to Neels Heyneke, a strategist at Nedbank Group Ltd in Johannesburg.
That’s not happening yet, with US conditions still near the loosest on record, according to the Goldman Sachs US Financial Conditions index. And while gauges of emerging-market stocks and currencies have pulled back from all-time highs, they’re still well up this quarter.
With the Fed unlikely to hike in 2021 or 2022, “monetary and financial conditions should remain easy for some time,” said Didier Lambert, JPMorgan Asset Management’s lead portfolio manager for emerging-market fixed income. “Emerging market central banks able to rein in inflation expectations in a credible way – such as Russia, Czech Republic or Brazil - may see greater demand for their currencies.”
While some commodities took a hit after the Fed’s latest rate signal, others remain supportive of emerging-market currencies linked to raw-material prices. Raw materials like copper, coal and iron ore hit all-time highs last month, with a rebound in the world’s largest economies stoking demand for metals and energy when supplies are still constrained.
That’s prompting Aberdeen Asset Management to take advantage of any weakness to add to its bullish bets on commodity-linked currencies such as the Brazilian real, as well as the Chilean and Colombian pesos.
“If anything, this is ratification that global growth is strong and so is the demand for commodities,” said Edwin Gutierrez, head of emerging-market sovereign debt at Aberdeen in London. “But let’s see how much of a shake-out there is in those.”
JPMorgan Asset Management plans to use any market volatility to invest in most emerging-market currencies that will benefit from a cyclical recovery and in selective high-yielding securities. Bullish positions in developing currencies aren’t “overextended,” suggesting that potential losses from a stronger dollar will be limited, said Lambert.
The shift toward tighter monetary policy in developing nations isn’t uniform, however. Some are continuing to support growth as the coronavirus continues to spread, or a new wave of cases emerges. — Bloomberg