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A rising US dollar and a “bundle of bad news” sparked the biggest sell-off in emerging market currencies since the early stages of the Fed's rate hike campaign two years ago.
JPMorgan's index of emerging market currencies has fallen more than 5 percent over the past two-and-a-half months, putting it on track for its biggest quarterly decline since September 2022.
The decline was broad-based, with at least 23 currencies tracked by Bloomberg falling against the dollar during the quarter.
The US dollar has been on a tear since late September as one of the so-called highlights “Trump trade”Fueled by expectations that US President-elect Donald Trump will impose sweeping trade tariffs and ease fiscal policy when he takes office next month.
“The dollar is absolutely front and center” as a driver of weakness in emerging market currencies, said Paul McNamara, senior director of emerging market bonds and currencies at fund firm GAM.
Trump Announced last month It would impose duties of 25 per cent on all imports from Mexico and developed market Canada, along with an additional 10 per cent on Chinese goods. The Mexican peso fell 2.1 percent during the quarter, while the offshore Chinese renminbi fell 3.7 percent.
More broadly, the South African rand – usually seen as an indicator of sentiment in emerging markets because it is easier to trade than other currencies – has fallen by about 2.4 per cent since the end of September.
Even when the benefits gained from holding local currency assets are factored into foreign exchange returns, only the currencies of countries that investors consider to be very risky, such as Turkey and Argentina, were in the green for investors this quarter.
The widening post-election sell-off has also affected so-called carry trades, when investors borrow in low-interest-rate currencies such as the dollar or yen to buy high-yielding emerging market currencies.
The US bank said that a basket of popular carry trades in emerging markets tracked by Citigroup achieved a return of only 1.5 percent this year.
Emerging market currencies last posted a quarterly decline of this size in 2022, when the Federal Reserve tightened monetary policy to curb runaway inflation. As interest rates rise in the United States, the widening gap with interest rates in emerging markets has increased pressure on the currencies of those countries.
The latest decline puts JPMorgan's emerging market currency gauge on track for its seventh consecutive annual decline.
Analysts said the weakness of the Mexican peso can be attributed in large part to tariff developments. They added that the picture is more complex for a number of other emerging market currencies, some of which are also under pressure from country-specific challenges.
“There has been a bunch of bad news in emerging markets,” said Thierry Wiesmann, global FX and interest rates strategist at Macquarie.
He highlighted China, citing “concerns about a downturn in the domestic economy (and) the possibility of the central bank continuing to ease policy,” and Brazil, citing “concerns about deficits and debt sustainability.”
The yield on China's benchmark 10-year bonds fell to less than 2 percent The lowest level in 22 yearsTraders are betting that the central bank will lower interest rates further to help stimulate growth.
The Brazilian real has also fallen to record lows in recent weeks, breaching the threshold of six reais to the dollar for the first time, as the new government's pledge of 70 billion reais (US$12 billion) in cost savings has done little to calm the situation. Concerns about its public finances.
“Brazil has a financial crisis on its hands,” said Ed El-Husseini, global interest rates strategist at Columbia Threadneedle Investments.
“Mexico has exceptionally low levels of productivity, growth and investment in an economy that is America's largest trading partner,” he said, while there are also issues with the quality of its constitution and institutions in the wake of recent judicial reforms.
While he noted that emerging markets in general “have not attracted capital inflows,” he added that “all of these countries have some special issues, and what is striking is that very few of these special issues are positive.”
Meanwhile, the South Korean won took a hit after President Yeon Suk-yeol declared martial law – a decision he later reversed.
The dollar's rise has also pushed the euro lower in recent months. This, according to Mark McCormick, head of FX and emerging markets strategies at TD Securities, is bad news for emerging market currencies that are “euro-centric,” including the Polish zloty and the Hungarian forint.
Macquarie's Wesman said the sell-off in emerging market currencies had helped revive the so-called “TINA” investment narrative — that there is no alternative to investing in the United States.
“There are no emerging markets these days that have strong economic stories,” he added.
Additional reporting by Joseph Cottrell in London
