Battered emerging market currencies will eventually bounce back from their beating in the past week on worries about the US-led trade war, but risks remain for currencies of commodity exporters inextricably linked to China, a Reuters poll found.
For the first time in more than a decade, China on Monday let its currency break through 7 per dollar, a key support level, in a sign Beijing might be willing to tolerate even more weakness in retaliation for tariff threats from Washington. This sent shock waves through risky currencies such as South Africa's rand and Brazil's real, which has lost over 3% since Thursday. But foreign exchange strategists polled this week are optimistic that by this time next year, most will have recouped those losses.
"Our top-down EMFX forecast now suggests currencies will first weaken in three months' time, then appreciate modestly in 12 months," noted Dirk Willer, head of emerging market strategy at Citi. "The Fed and the global growth story, along with US-China trade tensions are likely to remain drivers in the near term." Still, recent performance just magnifies what has been a lacklustre year so far for emerging market currencies.
The Reuters poll last month suggested these currencies had probably seen the best of a lukewarm year against the dollar as US President Donald Trump was then expected to back-pedal on his conciliatory tone from the recent G20 summit.
Trump did exactly that last week, and emerging market currencies showed similar weakness to last year's crazy August selloff, now seemingly looking ominously cyclical, but this time last year global growth was in question due to the trade war.
Emerging market currencies have underperformed more broadly in the past couple of years as rampant Chinese demand for raw materials waned and stimulus from asset purchases trickled off, first by the Federal Reserve and then the European Central Bank.
Trump's surprise move on Thursday to impose new tariffs on Chinese imports may eventually force the Fed to cut rates more than it had hoped was necessary, keeping rate differentials attractive to emerging markets.
"We think countries with high interest rates are likely to find it easier to attract capital flows due to the hunt for yield," Renaissance Capital wrote in a note to clients. Local problems in some countries have become more pronounced too, exposing deep structural problems irrespective of the global backdrop. In South Africa, President Cyril Ramaphosa is faced with serious fiscal troubles, while in Brazil, growth is expected to slow in 2020 despite pension reforms.
Though forecasters expect the rand to recover its recent losses, it remains a currency easily beaten down in times of heightened risk aversion, despite the fact its gold mining companies often benefit in times like this.
Gold is at a six-year peak as investors continue to pile into safe havens to hedge against heightened US-China trade tensions.
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