Higher rates set to shield emerging market currencies from Fed decline

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JOHANNESBURG / BENGALURU – The shift in global inflation expectations from transient to persistent will save emerging market currencies a massive sell off in the coming months as central banks consider or forecast short-term interest rate hikes, a revealed a Reuters poll of strategists.

As many remain under intense pressure, many emerging market currencies are expected to post a stronger final quarter of 2021 – as they did in previous years – particularly the South African rand, Russian ruble and Thai baht. .

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This comes despite the US Federal Reserve looking to slowly cut its $ 120 billion-per-month bond buying program later this year, already pushing up US bond yields and the dollar in anticipation of an upcoming rate hike at the end of next year.

“Persistent emerging market inflation is forcing a reaction from central banks, and as nominal carry for EMFX increases, real interest rates are struggling to enter positive territory,” noted Jonny Goulden, emerging markets strategist. at JPMorgan.

According to the Reuters poll from October 1 to 6, the South African rand and the Mexican peso are expected to stabilize around 3% in six months at 14.90 / $ and 20.225 / $ while the Russian ruble will gain more than 2% at 71.52 / $.

The relative stability of other major emerging market currencies, even though the US dollar remains strong, stems from the fact that many central banks have already raised their key rates.

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“The macroeconomic fundamentals of emerging markets are generally healthier, particularly the real ex ante rate cushion which has been replenished on a large basis following the rate hikes in emerging markets over the past six months,” wrote Ian Tomb, Emerging Markets Economist at Goldman Sachs, in a client note.

“Despite a slowdown in China, favorable commodity price winds are still robust for many emerging market exporters. Local emerging market markets did not experience the wave of capital inflows that preceded the taper tantrum, ”he wrote, referring to the last time the Fed cut its previous purchase program assets in 2013.

The Chinese yuan was one of the few currencies to end the following quarters strong after this episode. Other emerging market currencies ended subsequent quarterly periods weaker as the rand suffered a streak of nine quarters of losses.

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The yuan, heavily managed by Chinese authorities, fell to its lowest level in a month last week.

Trade was predicted to be relatively stable in 12 months despite broader concerns about the economy and its reliance on real estate as giant developer China Evergrande Group struggles with more than $ 300 billion in liabilities and faces one of the largest debt restructurings in the country.

Authorities are tightening control over the inner workings of China’s foreign exchange market, pressuring banks to trade less and in smaller ranges, as part of a sweeping campaign to curb speculation.

This suggests that other interventions could follow.

“CNY continues to ignore all of this,” said Michael Every, global strategist at Rabobank. “This is more of a political indicator than a macroeconomic or financial indicator: the signal sent is a signal of provocative strength, rather than reflecting an economy grappling with what looks like a new ideological direction, economic weakness and crisis. energetic. “

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Other free-floating currencies may well not fall more than they already have this year, with double-digit percentages in some cases.

The Turkish lira, which has plunged 16% this year after falling 20% ​​in 2020, is the first of the five currencies most vulnerable to a sell-off, followed by the Brazilian real, the Indonesian rupiah, the Thai baht and the Philippine peso.

The battered lira is expected to lose nearly 5% to 9,250 / $ in six months. Its central bank has thwarted the global trend by cutting interest rates.

(For more articles from the October Reuters currency poll 🙂

(Reporting by Vuyani Ndaba and Vivek Mishra; poll by Devayani Sathyan and Md. Manzer Hussain; editing by Ross Finley, William Maclean)

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