The emerging markets forex rally looks at risk of fading, dealing a blow to hopes that the sustained decline of 2015 was bottoming out and investors were ready to reinvest.
Russia’s rouble, Mexico’s peso and Indonesia’s rupiah, prominent among EM currencies that have gained in recent weeks, came under pressure after renewed worries about oil supply and the upcoming US Federal Reserve meeting gave fresh impetus to the dollar.
The working assumption of forex strategists at the start of the year was that the 2015 sell-off in EM would continue, underpinned by worries about China and the Fed’s normalisation policy.
Instead, EM currencies have been enjoying a revival this year, propped up by doubts about the US economy and the Fed’s ability to stick to its rate rise cycle. Signs of a bottom in the oil price also kept commodity currencies buoyant, while China has injected some stability in the renminbi.
In the eight weeks to last Friday, JPMorgan’s EM forex index had risen 6.7 per cent. This week, however, has marked an EM retreat and the index is off 1 per cent.
Fears of oil oversupply helped push Brent crude more than 2 per cent lower and back below $40 a barrel.
The rebound in the oil price was partly about positioning, said Charles St Arnaud, forex strategist at Nomura, but also about wrong assumptions that oil-producing countries would reach agreement to freeze output.
“We still have oversupply,” Mr St Arnaud said.
The turmoil in January and February prompted the market to write off rate rises this year. But March has so far seen calm settling over the market, and with investors wondering whether they were overly pessimistic about the US rate cycle, attention is turning to Wednesday’s Fed meeting for signs of hawkishness.
Daniel Tenengauzer, head of EM forex at RBC Capital Markets, said liquidity in EM would start to fade away as policy divergence returned as a dominant market theme — the Fed likely moving towards a June increase and little to no action coming from the European Central Bank, the Bank of Japan and the People’s Bank of China.
Mr Tenengauzer said: “EM fundamentals are weak pretty much everywhere. The main theme that would remain supportive is secular demand from ultra long-term investors.
“These are investors looking for long-term exposure because of positive growth and demographics in EM. They also tend to buy on extreme weakness, which is not the case here, in my opinion.”
Regis Chatellier, sovereign credit strategist at Société Générale, said fund managers had been shifting from local currency to hard currency debt for better risk-reward. “Global investors will remain on the sidelines of EM to a large degree,” he said.
Investors may be taking profit ahead of the Fed meeting, according to Peter Kinsella, at Commerzbank. “That makes sense given the rally we have seen in recent weeks,” he said.
Brazil’s real has scored the biggest rise in EM, gaining nearly 11 per cent in the past month, while assets have also found favour, helped by the commodity rally and hopes of a political breakthrough.
But the rally is running out of steam, Arnaud Masset at the online bank Swissquote said, “as the market realises that nothing has changed on the fundamentals side”. The real fell 2 per cent and was back towards R$3.75.