Sunday, January 16

Bears dominate emerging markets as central banks battle a new variant

If emerging market central banks were having difficulty propping up their currencies as the Federal Reserve intensifies its reduction in monetary stimulus, their task has become much more difficult.

Concerns over the emergence of the Covid-19 omicron variant sent risk assets plummeting on Friday, pushing MSCI Inc.’s indicator of developing world currencies into a deficit for the year and potentially on track. from its first annual drop in three years.

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Central banks in the developing world were weakened by the renewed strength of the dollar long before omicron was identified, and the tightening of policies from South Korea to Russia and Brazil did little to stem the exchange rate losses that are fueling the economy. inflation. The biggest losers this month are the Mexican peso, the South African rand and the Hungarian forint, all currencies from countries that raised interest rates in November. That puts bearish investors on the rise.

“Any factor that limits visibility makes life more difficult for central banks,” said Viktor Szabo, senior investment manager at abrdn plc in London. But a growing number of emerging market central banks are beginning to realize that the question of whether or not inflation is transitory is not really relevant at this stage. Inflation is high and sticky, even if it is caused mainly by supply-side shocks, and it can de-anchor inflation expectations and put pressure on currencies. ”

The threat of a more serious variant could also push key mature market policy makers, such as the Fed and the European Central Bank, to become more dovish, potentially balancing the need for a more aggressive adjustment in developing nations, said Olga Yangol, director. of emerging markets strategy at Credit Agricole SA in New York.

“In fact, the variant may hit emerging markets harder than other assets, particularly high beta currencies in Latin America and South Asia that are more sensitive to risk sentiment and more exposed to energy and tourism. , the sectors that are most affected by the pandemic, “she said.

‘Punished by the markets’
Political meddling has not helped. Turkish President Recep Tayyip Erdogan’s campaign for lower rates caused the lira to drop freely last week. The Mexican peso plummeted when President Andrés Manuel López Obrador’s appointment of a little-known Finance Ministry official to head Banxico fueled concern over possible government interference in the central bank’s independence.

“Any sign of government interference in monetary policy will be punished by the markets immediately, as long as the global currency headwinds tighten,” said Witold Bahrke, senior macrostraga at Copenhagen-based Nordea Investment. “Although the main reason we are underweight in emerging market currencies is the tightening of global monetary conditions, this is reinforcing the bearish market case.”

The correlation of emerging market currencies to short-term Treasuries is near the strongest level since 2014, underscoring the potential consequences of higher US interest rates. Investors are hedging against the risk of broader price swings as the dollar rose to its highest level since July 2020. JPMorgan Chase & Co.’s Implied Volatility Indicator in Developing Currencies rose last week above 10% by first time since April.

Real rates, which eliminate inflation, in most developing economies remain below zero, even after adjustment. That dampens the attractiveness of emerging market assets as US yields rise and concerns deepen over the durability of the recovery in developing economies. Investors will get more clues about the health of emerging markets in the coming days, with China’s official purchasing manager indices to be released and gross domestic product figures scheduled from Turkey to India and Brazil.

Policy dilemma
Hungary, which had followed its Central European counterparts the Czech Republic and Poland on the path of policy tightening, delivered its third interest rate hike in two weeks on Thursday, but failed to prevent the forint from falling to a record low. Meanwhile, the president of Brazil’s central bank, Roberto Campos Neto, who presided over the world’s most aggressive tightening cycle this year, warned on Wednesday against raising interest rates too quickly despite concerns about inflation by above the target.

The real is down more than 7% this year despite 575 basis points of rate hikes by the central bank, which has also signaled another 150 basis point hike in prospect next month. Political and fiscal risks led traders to ignore Selic’s raises.

“We expect currencies to remain under pressure until the end of the year and probably into early 2022,” said Paul Greer, a London-based money manager at Fidelity International, whose developing country debt fund exceeded 94% of its pairs this year. “It is difficult for emerging market currencies to compete with the US dollar today.”

These are the events and the data to take into account this week:

  • China’s manufacturing PMIs due Tuesday will likely show that the economy will stabilize in November as pressures from the Covid outbreaks and power shortages ease. Still, the indicators will point to an anemic growth pace, underscoring the need for policy makers to cushion the slowdown in the economy, according to Bloomberg Economics.
  • South Korea’s inflation in November is expected to decline from the previous month, while still staying above the central bank’s 2% target.
  • Turkey’s third-quarter gross domestic product figures on Tuesday may show that the economy surpassed its peak before the pandemic.
  • Kenya is expected to keep its key interest rate at 7% on Monday after inflation unexpectedly slowed for the first time in six months in October.
  • Traders will monitor the Mexican central bank’s quarterly inflation report on Wednesday for clues about the path of monetary policy.
  • Brazil will also provide a wealth of economic data, with September unemployment numbers scheduled for Tuesday, third-quarter GDP on Thursday, and October industrial production on Friday.

© 2021 Bloomberg LP

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