Wednesday, January 19

US yields aim to tighten grip on emerging market currencies

The slowdown in the economic recovery amid a resurgent pandemic is leaving emerging market currencies vulnerable to a sell-off if Treasury yields rise again.

While the influence of US borrowing costs on developing country currencies has waned in recent months, it may once again be prominent for riskier assets as the cushioning effects of the rally in the US weaken. China’s growth and low inflation, according to money managers, including Fidelity International and Credit Agricole CIB. .


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“A quick and very sharp move up in initial US real yields would be an extremely bad outcome for emerging market currencies,” said Paul Greer, a fund manager at Fidelity in London, which oversees about $ 700 billion. Dollars. “Twists in the US yield curve, particularly in the real yield space, will continue to be the dominant driver of confidence in the very near term.”

Emerging market currencies caught a glimpse of Treasury-led turmoil last week, when they posted the biggest loss since July 9, as the two-year yield rose. The pain could be compounded if key economic data, including South African consumer prices, confirm forecasts of a worsening macroeconomic outlook.

Beyond this week’s reports, the big clue from traders about the Federal Reserve’s policy direction may come from the Jackson Hole symposium later this month.

Correlation nervousness

The benchmark for emerging market currencies has fallen by around 2% from a record in June and is poised to erase its gains this year. While their 120-day correlation with US two-year performance remains close to zero, meaning they move independently of each other, money managers caution against complacency.

The declining correlation comes after Treasury yields softened in the past two months. Although lower US rates encouraged investors to seek higher returns, emerging market exchange rates did not benefit amid concerns that the highly infectious delta variant of the coronavirus would hamper domestic growth.

“Growth and liquidity could actually be the fiercest headwinds in the second half and also explain why falling US yields didn’t boost emerging market currencies in July,” said Witold Bahrke, a senior macrostraga of Nordea Investment based in Copenhagen. “The medium-term outlook for emerging market currencies is primarily driven by a trifecta of returns, growth dynamics and liquidity.”

While the sensitivity of emerging market currencies to Treasury movements has fluctuated over the years, US returns can never be discounted as an influence on local market returns, according to Aviva Investors.

“One of the biggest risks to the asset class remains a more destabilizing rise in real US returns, hurting capital and credit channels and leading to more significant capital flight in emerging markets.” said Kurt Knowlson, Aviva’s senior portfolio manager for emerging markets. market debt in London.

Possible winners, losers

In the event of a substantial and rapid rise in short-term Treasury yields, higher-yielding currencies within emerging markets may suffer the most. In particular, the Indonesian rupiah and the Turkish lira will see their return advantage eroded and vulnerability will increase as nations rely more on external financing, according to Credit Agricole CIB.

Meanwhile, currencies seen as supported by stronger growth, better Covid-19 management, and governments less reliant on external funding will be more resilient, said Eddie Cheung, senior emerging markets strategist at Credit Agricole in Hong Kong. , promoting the Taiwanese and Chinese dollar. yuan.

For the time being, however, the spread of the delta variant and lockdowns weigh on growth prospects in developing economies, where vaccination programs lag behind those in North America and Europe. China’s growing economic risks further dampen the attractiveness of developing nation currencies.

“The asset class will face a number of headwinds, including narrowing growth spreads with the US, sensitivity to the delta variant due to less advanced vaccine walls, relatively stiff inflation and concerns. on China’s tax and regulatory policy, “said Oliver Harvey, a London-based strategist based at Deutsche Bank AG. “The only trade-off is the relatively low levels of broader volatility in the markets.

China in focus

  • China’s economic activity slowed more than expected in July with all major data, from retail sales to industrial production, with no forecasts, data showed on Monday.
    • China’s central bank on Monday renewed most of its maturing medium-term policy loans, a move to support economic growth amid a resurgence of Covid cases.
    • China publishes its one- and five-year prime loan rates on Friday amid rising coronavirus cases. The one-year rate, currently 3.85%, is the benchmark rate for bank loans to companies. The five-year rate, at 4.65%, is the rate for mortgages.

Economic pulse

  • Second-quarter gross domestic product readings in developing economies will give investors a glimpse of how renewed closures and virus concerns are hurting growth.
  • Thailand’s main economic planning body cut this year’s economic growth forecast on Monday as the country’s worst Covid-19 outbreak causes record deaths, a drop in local demand and a delay in the arrival of tourists.
    • GDP is now expected to grow between 0.7% and 1.2% this year, down from the 1.5% -2.5% forecast in May.
    • GDP increased a seasonally adjusted 0.4% in April-June from the previous quarter, compared with the median estimate of a 1.1% contraction in a Bloomberg survey of 14 economists.
    • The baht is the worst performing Asian currency this year.
  • A reading of Colombian GDP on Tuesday will likely show a decline in the second quarter from the previous three months amid protests and new closures, according to Bloomberg Economics.
  • Chile will publish its GDP for the second quarter on Wednesday. Bloomberg Economics expects the economy to have extended its uptrend, rising above the pre-pandemic level.
    • The nation will release its checking account numbers for the second quarter on the same day.

Indonesia on hold

  • Bank Indonesia is likely to keep the benchmark rate unchanged at 3.5% on Thursday to support economic growth as the government takes steps to control the spread of the delta variant.
  • Southeast Asia’s largest economy broke a year of contractions in the second quarter, but annual growth in the third quarter could slow after mobility restrictions were imposed.
  • The rupee has weakened more than 2% this year.

What else to look at

  • Taiwan is expected to report moderate Friday export orders in July, but will remain at double-digit growth.
  • In South Africa, data on Wednesday may show that consumer price growth in July slowed to around 4.7%, close to the midpoint of 4.5% of the central bank’s target band. That will give policy makers scope to delay rising borrowing costs, after damage from last month’s deadly riots and the coronavirus pandemic allowed them to take a less aggressive stance in July.
    • The rand weakened for the second week in the five days through Friday.
  • In Argentina, traders will watch the June economic activity index figures on Thursday for signs of growth.
  • Investors will monitor Peru’s June Economic Activity Index on Monday for a breakthrough, though it will likely remain below its pre-virus levels.

© 2021 Bloomberg

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