Bumpy ride for emerging currencies over summer

Emerging currencies were under pressure this summer. Save for the Indonesian rupiah, Thai baht, Malaysian ringgit and Chinese yuan, emerging currencies has corrected against the US dollar since 30 June. It is mainly the CEEMEA currencies and, to a lesser extent, Latin American currencies that have underperformed for several reasons, one being the greenback’s rebound in reaction to the Federal Reserve’s intention to tighten monetary policy, the renewed political strains over Ukraine and Gaza, concerns Argentina was heading for selective default, the steady decline in commodity prices and, finally, the deterioration in growth prospects for the global economy.

Logically, the Russian ruble recorded the sharpest correction in reaction to the escalation of tensions in eastern Ukraine after western powers ratcheted up sanctions against Russia. However, other Eastern European countries (Poland, Hungary and Romania) are also affected by this situation because of their trade exchanges with Russia and of the sanctions imposed by Russia (embargo on agricultural products, etc.). One can expect economic growth in CEEMEA countries to be affected by the sluggish European growth and strained relations with Russia, all of which risks penalising certain CEEMEA currencies, this against the backdrop of a steady decline by the ruble stemming from the fact this currency is overvalued.

Furthermore, CEEMEA economies face deflationary pressures, which prompted Hungary to slash monetary policy rates, while Poland is pondering the need for a further monetary easing given concerns over the vigour of the economic growth.

The Turkish lira is penalised by the situation in neighbouring Iraq and by the repeated interest cuts when inflation shows no sign of subsiding contrary to the central banks’ expectations (annual inflation reached 9.38% in July).This is undermining the lira even though the country’s stronger economic growth and smaller current account deficit have gone some way reassuring the market. In the short term, however, the currency will remain under pressure due to political uncertainties over the new government following Recep Tayyip Erdogan’s victory in the presidential election. The USD/TRY could move back towards 2.25 in the short term. The South African rand put up a stiffer resistance after the SARB decided on another interest rate hike in July, also because the Ukraine-Russia crisis is distant geographically.

Turning to Latin American currencies, the sharpest correction was recorded by the Chilean peso, which was consistent with our trade idea of 3 July to play a recovery of the USD/CLP towards 577 (+4.7%) after the interest rate cut decided by the central bank in reaction to the country’s weak economic growth.

In our view the peso still has some downside in the short term, so that the USD/CLP could go on to test 592.

The Brazilian real also weakened after the central bank decided to mark a pause in its monetary tightening. The market was also disappointed at the country’s growth prospects in the absence of structural reforms and with the outcome of the looming presidential election more uncertain than expected. The central bank has managed to limit the real’s decline through market interventions, but the trend nonetheless remains bearish for the currency over the medium term despite the very attractive interest rate levels. The Mexican peso has also been penalised by the weaker-than-expected growth, prompting the central bank to ease its monetary policy. In the short term, the expected rebounded of the US dollar at the end of the year means that that the USD/MXN could head higher towards 13.30.

Finally, Asian currencies remain solid despite the appreciation of both the US dollar and Chinese yuan. While the Thai baht rebounded after political tensions abated in the country, the Indonesian rupiah shows signs of recovering after the pro-business opposition party’s victory in the recent elections. The Malaysian ringgit has been bolstered by the stronger-than-expected economic growth, while the Indian rupee is on hold waiting for structural reforms, even though the current account deficit has improved sharply in 2014. Finally, the South Korean won has been slightly penalised by the interest rate cut decided by the South Korean central bank in reaction to the slower growth and weaker inflation.