EM FX Weekly – EM FX lower

by: Georgette Boele

  • EM FX failed to profit from dollar weakness…
  • …except Eastern European currencies
  • Reserve Bank of India is done with monetary easing for now

EM FX failed to profit from dollar weakness…

Surprisingly, emerging market currencies failed to profit from US dollar weakness earlier this week. Why is this? Emerging market currencies are not only sensitive to developments in the US dollar but also sensitive to developments in bond markets and commodity markets. The sharp rise in government bond yields in Germany and the US have brought home memories of times that these higher yields coincided with significant drops in emerging market currencies (for example during the tapering dry-run). This effect has more than outweighed the soft US dollar.  What is more, weakness in Brent oil, copper and precious metal prices have variously weighed on the Russian ruble, Chilean peso, Mexican peso and South African rand.

…except some Eastern European currencies

The economies of Poland, Czech Republic and Hungary are in relatively good shape and the prospects are bright. In addition, weaker commodity prices do not hurt them because they are mainly commodity importers. The Polish central bank left monetary policy unchanged at 1.5%. Governor Belka made it clear that that only a significant weakening of the macro situation would change the Bank’s stance on rates on hold from here. In addition, investors seem to have become more relaxed about the political situation in Poland. These developments have supported the Polish zloty.

Meanwhile, official of the central bank of the Czech Republic said that the economy does not need a weaker Koruna cap now. This comment has supported the Koruna. Up to now, the central bank has always indicated that it would be open to move the cap in case the economy would need this. There is an increased likelihood that at the next meeting the central bank will drop the sentence that it is ready to increase the floor in EUR/CZK. However, it is unlikely that it will also remove the cap of the Koruna versus the euro.

Reserve Bank of India is done for now…

On 2 June, the Reserve Bank of India lowered official rates, but it said that it will wait to assess monsoon rains before acting again. It also lowered growth forecasts and said that weather related events (monsoon and El Niño) could push up inflation. The possibility of an El Niño weather phenomenon occurring this year has attracted attention. This is because if an El Nino shock were to occur, the impact on commodity prices (especially agricultural prices) and some economies could be significant according to an IMF study that was released in April. El Niño conditions usually coincide with a period of weak monsoon and rising temperatures in India. This could greatly damage agricultural crops in India, which could lower income for farmers and could have an upward effect on agricultural prices. If inflation were to rise, it is unlikely that the central bank will lower official rates again. Such an environment could weigh on the Indian rupee.