Divyang Shah
IFR Senior Strategist
Since then some central banks have taken steps to make their currencies more attractive, whether through higher interest rates, intervention (Brazil and Turkey) or talk about reforms.
The circumstances of Fed tapering have changed sufficiently that even if the Fed were to go earlier than expected, a repeat selloff in EM currencies is unlikely.
Indonesia continued building its defences with another surprising rate hike this week that took them up another 25 bps to 7.5%. This won’t be the last rate hike from Indonesia. India’s higher rates, support for oil importers and market reforms also seem to have helped calm investors after the anxiety attack back in August.
But as bets rise for the Fed to taper as soon as December or January, doubts linger about whether the vulnerable EM countries have done enough to protect themselves.
A few months since the initial EM currency slide, some key aspects make an eventual tapering less of a shock:
1) Fed tapering will likely happen with a strengthening of forward guidance, and thus should prove less of a shock to Treasuries and thus EM bond markets
2) the China hard landing story has gone off the boil, with the PBoC removing excess liquidity in a controlled manner
3) the ECB and BoJ are likely to partly compensate for less Fed liquidity even if they do so in an uneven and unpredictable manner, and
4) much of the fast money forced liquidation and selling has already happened.
That suggests that any surprise Fed tapering in December or January is likely to be less severe on the currencies of EM c/a deficit countries.
The renewed currency weakness since late October makes clear that market players should not to get too carried away with any optimism, especially as IDR, ZAR and TRY fall close to their Aug/Sept lows against the USD. The slide in INR and BRL has also accelerated recently.
Sentiment toward the EM c/a deficit currencies remains very fragile, so expect continued - but more controlled -currency weakness.
