Emerging market currencies are likely to set new lows in coming months as China scrambles to curb market volatility and the US moves ever closer to raising interest rates for the first time in nearly a decade, a Reuters poll showed. Latin America will probably take the hardest hit, with the Brazilian real weakening toward an all-time low of 4 per dollar, although currencies in Africa and Asia are also set for further turbulence as expectations firm for a Federal Reserve rate hike next month.
Steep currency losses have prompted renewed government intervention in Mexico and have fueled debate about a currency overshoot in Brazil, where the real has already lost just under a third of its value since the start of the year. In Turkey and South Africa, the currency slump could trigger rate hikes later this year as they fuel inflation, singling them out from over three dozen central banks which have eased policy since January amidst a global scenario of weak economic growth.
Challenging conditions for carry trades, where investors borrow with cheap money to reinvest in higher yields elsewhere, complete the bearish outlook for emerging currencies. Median forecasts in the poll of top currency strategists projected the Brazilian real to lose a further 1 percent in a year on top of a 30 percent slide since January, the South African rand about 1 percent and the Turkish lira to weaken over 4 percent.
Forecasts for the Brazilian real were spread across the board, from 3.25 to 4.00 reals per dollar, as risks of a presidential impeachment raised uncertainty. The Mexican peso, long expected to strengthen as the government opened the country's oil sector, is now forecast around the current 16-per-dollar mark through at least mid-2016, near all-time lows.
India's and Indonesia's currencies, seen by some analysts as offering better returns for their risks, are expected to weaken as well, but not as much. "Latin American currencies are at the eye of the storm and short Latam FX is a once-in-a-lifetime trade at this juncture," wrote Societe Generale analysts Dev Ashish and Bernd Berg. "The Brazilian real will quickly drop towards 4.00 per dollar over the next weeks," Berg added in a separate report on Wednesday.
Much will depend on how rates rise in the world's largest economy in September and beyond. Fed policymakers' rhetoric supporting a hike stands in contrast to economic data that suggest the recovery is feeble by historic standards and still not generating much inflation. Unless pay rises significantly, there is little chance of inflation returning to the Fed's 2 percent target over a two-year horizon, especially with falling global commodity prices and a weak Chinese economy keeping a lid on import prices.
Still, with markets only pricing in a rough 50 percent chance of a September hike, risks are skewed towards further dollar gains, BofAML strategists wrote in a note. Another potential risk is China, where its stock market has plunged by about a quarter since early June and brought into sharp focus the state of the world's second largest economy that is reportedly growing at a 7 percent clip.
A host of indicators have recently shown Chinese manufacturers are struggling with falling new orders even as the central bank cuts interest rates and adds liquidity to stabilise its financial markets, boost credit growth and consumption. And as China falters and the US dollar gains, commodity prices tumble. Oil producers such as Colombia, Mexico, Malaysia and Russia are likely to have underperforming currencies as crude prices dip, while the Chilean peso is likely to struggle with weak copper prices, said Mario Castro, a Nomura strategist.
African currencies are also vulnerable to lower commodity prices, with some sub-Saharan exchange rates facing further revaluations after last year's drops. Falling currencies have sent investors on the lookout for carry: opportunities to buy low and sell high. BofAML's valuation model suggests eight emerging currencies, rather than five previously, could rebound after the recent sell-off, including the rand and the lira. Volatility has spooked investors though, especially as it hurts carry trades. Brazil is the greatest example, where a mouth-watering 14.25 percent interest rate has not yet attracted inflows big enough to halt the currency decline.