- Emerging market currencies have continued to plummet on politics, China and commo…
- …the Fed will be another headwind, leading to further weakness in EM FX in coming months
- Japan GDP growth shrinks adding to case for more monetary easing from the BoJ
EM FX – from bad to worse
This year the performance of emerging market (EM) currencies has gone from bad to worse. What explains the fall and what happens next? One factor explaining the weakness is the substantial drop in commodity prices, which has hurt major commodity exporters (CRB has dropped by around 14% year-to-date). Renewed weakness in oil prices driven by oversupply has weighed on the currencies of oil exporters such as the Russian ruble and the Mexican peso.
In addition, the domestic demand outlook has deteriorated in most EM economies. Risks to China’s economic growth have been most in focus. This has sent ripples to the overall EM outlook, weighing on currencies.
Moreover, political uncertainty has also been a major driver of weakness in the Brazilian real and the Turkish lira. The worsening fiscal and political woes in Brazil make it harder to break out of the vicious economic spiral and the risk of downgrade by S&P to speculative grade has not disappeared. Therefore, the real leads EM FX table in being the worst performing currency so far this year. In Turkey, coalition talks broke down and early elections are quite possible. This has sent the lira to a new low this year.
Furthermore, the change in FX policy in China has also unnerved EM currencies, especially currencies that export to or compete with China in terms of exports (also see our FX Asia Watch published today). The Mexican peso also falls in this category. Finally, Fed rate hike expectations have also weighed more generally.
Overall, we expect further weakness in EM FX in coming months, especially Asia FX, the Brazilian real and Turkish lira. The start of the Fed’s tightening cycle will be the main negative going forward. On the other hand, an eventual recovery in oil prices should provide some respite for the Russian ruble and the Mexican peso (as well as stronger domestic growth).
Japan’s GDP growth shrinks…
Japan’s GDP growth slowed to -1.6% qoq saar in Q2, down from +4.5% in Q1 and +1.4% in Q4. The series is volatile, but the underlying trend looks weak. We expect the economy to pick up gradually in the second half of the year. Profits are being buoyed by lower oil prices, while global demand should firm. However, we think the pace of recovery will not be enough to push up inflation towards the BoJ’s 2% target.
…adding to likelihood of more monetary easing
The weakness in demand suggests that the BoJ will likely opt for additional monetary easing early next year. By early 2016, the pressure for the BoJ to maintain the credibility of its inflation goal will build. This should lead to more easing, with the central bank likely to step up and/or extend QE. We expect the yen to decline relative to the US dollar to 128 by the end of this year and 135 in 2016, as a result of widening monetary policy differentials between the Fed and the BoJ.