Variation in the performance of currencies has been a striking trend in emerging markets since the start of the coronavirus crisis. Made particularly noticeable by the extraordinary demand for US dollars when investors liquidated positions across many asset classes in March, it has persisted since then.
Analysis by Mosaic Smart Data shows that overall emerging market currency liquidity during the period of May 20 to June 10 was at 66% of its pre-Covid level.
Within specific pairs, USD/MXN average spreads were about four times higher and liquidity had fallen by around half, while USD/ZAR liquidity saw spreads double and liquidity also halve.
In contrast, USD/EUR volumes were 11% above the pre-Covid average.
Idiosyncratic risk, disparities in dollar liquidity access and external funding needs, the extent of and capacity for currency intervention, and the effectiveness of countries’ strategies for tackling Covid-19 are the main reasons why the Brazilian real and the South African rand have fallen much further than, for example, the Philippine peso.
The MSCI Emerging Market Currency Index for the period January to March shows a 25% reduction in the value of the real against the dollar, while the rand fell by 26% between the end of 2019 and the end of March this year, whereas the Philippine peso was down by less than 1% over the same period.
The real has been hammered by a combination of political turmoil, sharp economic contraction and unclear outlook for recovery, as well as a confused response to containing the pandemic, Phoenix Kalen, emerging markets strategist at Societe Generale, tells Euromoney.
The rand, meanwhile, suffered from the loss of South Africa’s last investment grade credit rating, USD liquidity stress and escalating fiscal woes.
Markets were quick to unwind long South African government bond positions in anticipation of a Moody’s downgrade that came at the end of March and meant that the country’s bonds would be excluded from the FTSE Russell World Government Bond Index, says Barclays FX and EM macro strategist, Nikolaos Sgouropoulos.
“Throughout most of the sell-off in March and April, EM Asia fared better, likely reflecting the fact that the region went through the virus earlier and support from increased stimulation by China,” he says. “More recently, however, a second wave of outbreaks in places like China and Korea, in addition to rising US-China tensions, has muddied the outlook.”
The collapse in oil prices has weighed heavily on the Colombian peso and the Russian rouble. But headwinds for the rouble were also soon overcome by relatively high real rates and confidence in the macroeconomic setup, according to Ebrahim Rahbari, global head of FX analysis and content at Citi and the bank’s chief G10 currency strategist.
He tells Euromoney that he was also surprised by how resilient the Philippine peso had been, since “other supportive factors such as relatively limited government debt and deficits are notable, but not drastically different from other peer countries.”
According to Daniel Tenengauzer, head of markets strategy at BNY Mellon, the initial downward pressure on the Mexican peso (23% off its January 1 level against the dollar by the end of March, according to the MSCI Emerging Market Currency Index) was a surprise.
“I did not expect to see so much movement, particularly in a country whose fiscal health is pretty robust,” he says. “The central bank in Mexico is usually extraordinarily reluctant to interfere in the market, although it did come out with a few surprise cuts that slightly outpaced the Fed.”
|Ebrahim Rahbari, Citi|
Rahbari expects the rouble to outperform, but says that even though valuations have adjusted a lot, it is still too early to buy currencies in Latin America, and notably in Brazil.
“This is due to major uncertainties and (by EM standards) unusually aggressive monetary easing,” he tells Euromoney. “Within the region, we see scope for outperformance for the Mexican and Colombian currencies.”
Barclays retains the view that higher risk premia in emerging markets are needed and expects broad FX depreciation versus the dollar through the third quarter of the year. The rebound in global growth remains highly uncertain and is extremely important in determining whether or not capital gets deployed to emerging markets.
Sgouropoulos says there will be continued high levels of differentiation, with countries where currencies have already rallied likely to underperform.
“Similarly, rising US-China tensions should keep risk premia in northern Asian EM FX elevated and weigh on the respective regional currencies [the South Korean won and the Taiwan dollar],” he adds.
As the extent of global economic damage becomes clearer over the next few months… emerging market currencies may encounter another period of weakness before embarking on a more sustained recovery
– Phoenix Kalen, Societe Generale
Kalen acknowledges the partial recovery in emerging market currency trading that has taken place over recent weeks, but warns that this short-term rally, buoyed by the strength of global policy responses, will soon cease.
“As the extent of global economic damage becomes clearer over the next few months, as economies struggle to balance easing lockdown restrictions and battling the virus, and before an effective vaccine is widely distributed, emerging market currencies may encounter another period of weakness before embarking on a more sustained recovery,” she concludes.