Emerging-Market Currencies: It’s Not Just About the Fed

The Fed is in focus for emerging currencies, but China, commodities and domestic problems are increasingly weighing on performance too.

By Richard Barley

Federal Reserve Building in Washington, U.S. The Fed is in focus for emerging currencies. Photo: Samuel Corum/Anadolu Agency/Getty Images

Emerging-market currencies have dealt investors an unhappy hand as focus on a U.S. interest-rate increase has built. The Brazilian real has fallen more than 30% against the dollar this year; the Turkish lira hit a record low this week; the Malaysian ringgit is down 17%.

But the U.S. Federal Reserve isn't the only risk investors have to contend with: commodities, Chinese growth and domestic vulnerabilities are in the mix. A Fed rate increase might reduce uncertainty, one component of the emerging-market selloff; a pause might also offer temporary relief for battered investors. Either way, it won’t be universal.

True, the roots of the pain in emerging foreign-exchange markets lie with the Fed. The so-called taper tantrum of 2013 first raised concerns about countries that were over-reliant on loose global monetary policy. The Turkish lira fell 17% that year, for instance. But the slide has continued since then, and so is far from a new phenomenon.

Yet a full-blown crisis hasn’t emerged, unlike in previous periods of dollar appreciation. One reason: the pressure has instead been borne by investors in local-currency assets, which have become a bigger source of financing for emerging nations. Fitch says that of the $1 trillion in sovereign external debt added by rated nations between 2008 and 2014, half represents cross-border borrowing in local currencies.

Now, while the Fed is in the spotlight, the picture is actually more complicated. The emerging-market growth engine, with China at its heart, has flagged, hitting commodities prices and producers. The meltdown in oil turned the Russian ruble from being a currency that remained stable when the taper tantrum hit into one of the worst performers: since mid-2014 it has halved in value against the dollar.

And there are home-grown problems as well. The Brazilian real’s latest decline, to its weakest since 2002, followed a downgrade to “junk” status by Standard & Poor’s due to the country’s fiscal and political challenges as it struggles with a sharp economic downturn. Turkey too faces political turmoil. Russia failed to capitalize on a period of relative stability to diversify its economy away from oil.

Even if uncertainty around the Fed’s intentions lifts, in particular if it were to signal a very cautious approach to raising rates, emerging-market currencies look set for only temporary relief. Those with fewer domestic problems should fare better, particularly since revulsion for emerging-market assets has reached high levels. The Mexican peso, for instance, may offer opportunity, says BlueBay Asset Management. Société Générale SCGLY 1.11 % ’s asset allocators favor the Polish zloty and Hungarian forint against the South African rand and Turkish lira, as the European growth outlook is brighter.

But for countries with domestic troubles or exposed to a slowdown in China, foreign-exchange woes likely won’t fade quickly. While weaker exchange rates can act as a safety valve, they also threaten to import inflation and damage companies that have borrowed heavily in dollars.

Unless these countries take action, U.S. rate increases could only raise the pressure.

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