Strengthening US$ puts heat on emerging market currencies

Dubai

AS IF emerging-market investors do not have enough to worry about - with political flare-ups and central bank surprises galore - the US dollar's strength is poised to pile further pressure on currencies from the real to the rand.

As the US dollar clocked up its longest rally since 2015, the MSCI Emerging Markets Currency Index closed last Friday below its 200-day moving average for the first time in more than a year, heralding more losses. The gauge slid 1.3 per cent in the week, its worst performance since 2016. Not one developing-nation currency rose last week as the US dollar advanced, with US 10-year yields closing above 3 per cent the last five days.

For GAM UK Ltd's Paul McNamara, nothing worries him more than the strength of the US dollar. "The rest is noise," the London-based fund manager said.

What is more, the negative correlation between the US dollar and developing-nation currencies is deepening.

To minimise the potential damage from the US currency's revival, Mr McNamara is using the Canadian dollar and the euro to invest in emerging-market (EM) assets. A Bloomberg currency index that measures carry-trade returns from eight emerging markets, funded by short positions in the US dollar, has declined to the lowest in a year.

"Unless the fresh set of US data scheduled next week is seriously disappointing, EM currencies will struggle to trim their recent losses against the dollar, which is supported by rising yields on US Treasuries," said Piotr Matys, a strategist at Rabobank in London, said last week. Markets expect the Federal Reserve to raise rates at least twice more this year, he added.

The combination of higher debt levels and share of debt denominated in foreign currency means that many emerging markets are now more exposed to US dollar appreciation than in 2009, amid signs that the robust growth in developing economies may be slowing, the Institute of International Finance said in a May 17 note.

While the US Treasury will sell some of its largest offerings since 2010 this week, a slew of Fed speakers may reiterate plans for gradual rate increases.

The sell-off in developing nation currencies is hurting other assets. Emerging-market local-currency government bonds declined for a sixth week, the worst run since 2016. Developing-nation stocks retreated 2.3 per cent last week.

What will central banks do? Argentina's central bank will probably hold its benchmark rate steady this week after raising it to 40 per cent earlier this month to defend the peso. The Argentine currency has plunged almost 20 per cent in the past month, forcing the government to spend a 10th of its foreign-exchange reserves to defend it and seek help from the International Monetary Fund.

The Bank of Korea (BOK) is expected to keep its key interest rate on hold at 1.5 per cent on May 24. Odds are increasing against further policy normalisation after BOK governor Lee Ju Yeol sounded caution on the economy, Prakash Sakpal, a Singapore-based economist at ING Groep NV, wrote in a May 17 note. Mr Lee said last Thursday that it is difficult to remain optimistic even though the economy has grown steadily, given uncertainties over the US-China trade dispute and the impact of monetary policy normalisation in major countries. His remarks followed the latest rhetoric from North Korea, which has threatened to pull out of a proposed summit between its leader Kim Jong Un and US President Donald Trump in June if it is pressured to surrender its nuclear weapons.

Hungary's central bank will hold a rate meeting on Tuesday, where investors will be focusing on any reaction to the recent market volatility. Policymakers have used a variety of unconventional tools to lower borrowing costs since last August, but the sell-off had reversed most of the impact and scepticism is growing over how long the bank can stick to the measures.

Central banks in South Africa, Ghana, Nigeria and Ukraine will also decide on policy this week.

The roster of big-name investors and chief executive officers attending Russia's annual St Petersburg International Economic Forum has withered since the annexation of Crimea, and this year's event takes place in the shadow of the toughest US sanctions to date. Still, with a raft of top local officials speaking at the event, traders will be keeping a close eye on the event. The forum runs May 24-26.

Meanwhile, foreign ministers from the Group of 20 countries are gathering in Argentina for their annual meeting. Officials from the UK, Canada, Mexico, Japan, China, Australia and Germany are due to attend.

Global trade tensions are showing some signs of improvements after the Trump administration and China called an economic truce as both parties agreed to put tariffs on hold while they execute a framework to rebalance trade.

China and the US agreed to "substantially" reduce the US trade deficit in goods with China, which reached US$376 billion last year. Beijing promised to "significantly" increase purchases of US goods and services. But there was no dollar figure attached.

Venezuelan bonds may come under pressure when markets reopen on Monday after Sunday's presidential vote in which incumbent Nicolas Maduro won a second six-year term amid dubious electoral conditions.

The result continues two decades of strongman rule by the late socialist president Hugo Chavez and Mr Maduro, 55, his hand-picked successor.

The nation's benchmark sovereign bonds, which are leading emerging-market returns this year, fell to their lowest a week ahead of the polls.

In Brazil, the Finance Ministry is expected to revise down its yearly growth estimate, currently at 3 per cent, following a series of disappointing economic indicators in the first quarter. Investor anxiety, as measured by the real's one-month implied volatility, rose to the highest in about a year.

Finally, Taiwan is due to report gross domestic product growth data for the first quarter on May 25 after data on Monday showed that Thailand's economy grew faster than economists estimated last quarter as exports and tourism rose. BLOOMBERG