Caution in order for emerging currencies in short term

The prospect that asset purchases will be tapered earlier than expected in the US has led to further outflows of capital invested in emerging assets. In particular, local emerging debts have suffered significantly, as underlined by the right-hand chart below.

It is the currencies of countries with still fragile fundamentals (current account deficit, fiscal deficit and galloping inflation) that have experienced the sharpest correction. Cases in point are the Brazilian real, South Africa rand and Indonesian rupiah (even though this last currency has been buoyed by a 25bp hike in the BI rate to 7.25%). At the same time, some currencies such as the Turkish lira and Indian rupee, which have very fragile fundamentals, did not correct sharply despite the falls recorded by local debts. The rise in Indian short rates on 29 October probably contributed to the strains at the long end and limited the currency’s depreciation. The Reserve Bank of India’s determination to push through a reform of the banking sector may also have helped limit the currency’s correction. As for the Turkish lira, it did not suffer despite a sharp rise of more than 80bp in the 5-year rate and still very high inflation of 7.7% in October. This may be linked to the good macroeconomic data (5.8% month-on-month increase in industrial production in September). The Czech koruna corrected sharply in the face of the central bank’s determination to peg the EUR/CZK around 27. The Hungarian forint was affected amongst other things by the decision to cut the monetary policy rate to 3.4%. Finally, the South Korean won appears to be shrugging off the rise in US long rates due to some good macroeconomic data (1.1% GDP growth in Q3, increase in current surplus in September) and also because long rates are not very attractive in yield terms.

Despite the very dovish tone of the Federal Reserve, notably Janet Yellen and Ben Bernanke, emerging currencies will remain on the defensive in coming weeks. In the run-up to the publication of the November Employment Situation Report, expectations that the Federal Reserve’s tapering will start in January should heighten, which will weigh of US treasuries, by the same making emerging assets less attractive. Once again, it is the currencies of countries with still fragile fundamentals (significant current account and fiscal deficits, galloping inflation and still faltering economy) that will suffers, notably the Indonesian rupiah, South African rand and Brazilian real, and to a lesser extent the Indian rupee and Turkish lira. High beta currencies, other the ones mentioned above, such as the Mexican peso, Chilean peso, Malaysian ringgit and Hungarian forint will also be under a lot of pressure. A stabilisation of emerging currencies is likely only once the Federal Reserve’s tapering gets under way, i.e. once monetary uncertainties have been lifted, sometime in February.