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Investors turn their backs on emerging markets currencies

posted onOctober 15, 2020

Investors seem to be losing their confidence in investing in emerging markets (EM) currencies. The Chinese yuan, the Brazilian real, the Turkish lira and seven other major EM currencies have underperformed their developed market peers by nearly 14% this year, Nordea Research data shows, set for their biggest underperformance in more than a decade.  

For comparison, during the aftermath of the 2008/09 financial crisis the same basket of currencies gained as much as 25% thanks to massive fiscal stimulus from China.

The underperformance can be attributed to a number of reasons, including drastic rate cuts by emerging market central bankers, an uncertain economic outlook and sizeable outflows.

Relatively higher interest rates in emerging markets had been luring foreign investors but now central banks are being forced to slash rates to support their ailing economies.

Central banks across a group of 37 developing economies have cut rates for 20 straight months. In September, EM banks delivered a net four cuts, the lowest number of reductions since June 2019 while in August they delivered a net seven cuts, according to Reuters calculations.

“A raft of recent monetary policy decisions – in countries like Brazil, South Africa, Indonesia, Russia – suggest that EM central banks are by no means as keen as they used to be to cut policy rates,” Reuters quoted David Lubin, head of emerging market economics at Citi as saying. “This raises the question of whether we have reached the end of the rate-cutting cycle” he added.  

emerging market currencies

Last month, the Central Bank of Turkey hiked its benchmark rate for the first time since 2018, surprising financial markets. Policymakers' move aims to rescue the spiraling lira currency and curb double-digit inflation. Hungary's central bank also unexpectedly increased the interest rate on its one-week deposit facility by 15 basis points to 0.75% on Sept.24. Signs that the easing cycle might be running out of steam?

When it comes to the US dollar, a key driver of EM asset performance, Nordea’s analysts wrote in “The global and financial market outlook” in September.

“The USD will likely weaken over the next 12-18 months against most, if not all, major peers, with the biggest question mark surrounding the emerging market currencies.” 

Meanwhile, foreign investor holdings of major EM local currency debt has fallen sharply to near $400 billion from $550 billion at the start of the year, according to TS Lombard data.

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