EM malaise poised to linger longer
By Steven Englander
NEW YORK: Emerging-market currencies are in the midst of their fifth major weakening trend since 2011. The origins of the current downturn are broadly similar to the earlier four episodes, which is to say that a combination of rising US Treasury yields, sluggish equity markets and risk aversion are to blame. Whats different now is that these factors may not dissipate as quickly.
The sensitivity of EM currencies to higher rates is striking. Every major upward move in yields since 2011 has triggered currency weakness among countries with large current-account deficits. So unless there is a recession or a serious slump that would reverse the rise in US yields, the pressure is likely to continue.
The 2011 and 2015 episodes were largely confidence events, as they came first with the US government shutdown and then with Chinas surprise decision to devalue the renminbi. Both were accompanied by weakness in equities.
The drop in bond yields reflected pessimism. The 2013 and 2016 episodes were driven purely by higher bond yields. It didnt matter what equities were doing. The current episode is one of sharply rising yields and, at best, a sideways equity market.
What are the takeaways?
The 2000s-era of EM market leadership are gone, even if the sequence of profound 1990s EM currency crises is not quite back. It is not just the frequency of these episodes, but the drivers. The two big emerging market currency sell-offs of the 2000s were driven by global downturns, and emerging led the charge back once recovery began.
The EM downturns of the last couple of years were driven by the normal ups and downs and random shocks. These come more frequently than global downturns, and the recoveries among current-account deficit EM currencies are shallow. There are two sets of EM currencies. The high current-account deficit countries lose ground when there is stress and rarely recover when stability is restored.
They fall versus the euro as well as the dollar. On a carry-adjusted basis, these currencies have weakened since 2011.
Currencies of current-account surplus countries have typically declined modestly against the dollar, and often recover those losses when conditions stabilise. The currencies are very stable over time versus the euro. When we talk of crisis, we are dealing with an important but limited set of countries.