- Emerging market currencies recover ahead of the FOMC meeting
- Dovish tone of the Fed helps EM FX
Emerging markets recover ahead of FOMC
In the past week, most emerging market currencies recovered as short positions were reduced ahead of FOMC meeting later today. The Russian ruble rose by more than 3% as oil prices recovered and the central bank signalled that there are limitations to further rate cuts. The South African rand also was supported as the current account deficit narrowed and retail sales were stronger than expected. In Asia, the South Korean won (KRW) recovered by more than 1% as financial markets pared down rate cut expectations. Sentiment in the KRW also improved after rating agency S&P upgraded South Korea’s sovereign assessment. A stable Chinese yuan has also supported investor sentiment in most Asian currencies. On the other hand, the Indonesian rupiah (IDR) underperformed as the trade surplus in August was weaker than expected. Credit rating agencies have also expressed concerns that a weaker IDR will put strain on domestic companies’ credit quality.
Dovish tone Fed supports EM FX…
The FOMC strikes a dovish tone but continues to signal rates hike this year. Our view is that a rate hike in December remains likely, but concerns about the global economy suggest that risks of a delay to 2016 are now larger. The US dollar moved lower because of concerns about the outlook. In addition, financial markets had priced in around 30% probability of a rate increase today. As no rate hike was delivered this also weighed on the US dollar. Financial markets have slightly priced out the possibility of a rate hike this year. Investors now expect a lower amount of rate increases next year. This and lower US Treasury yields supported emerging markets currencies.
…but any recovery in EM FX to be transitory
However, we expect any recovery to be small and transitory as it is still likely that the Fed will hike later this year. In addition, emerging market central banks are unlikely to tolerate a strong rally in domestic currencies as exports and inflation dynamics remain unfavourable. Most emerging market central banks’ foreign currency reserves have declined in recent months as they seek to limit the depreciation of their currencies. Hence we expect central banks to replenish their FX reserves during period of domestic currencies’ strength.