The sell-off in emerging market currencies in recent months has not claimed every scalp — yet.
Currencies of oil importers and those with hawkish central banks have been touted as the last bastions of relative strength among developing economies as the strong dollar has rampaged across many markets in Latin America, South Africa and Asia.
Some, such as the Thai baht, Indian rupee and Philippine peso have lost less than 2 per cent against the US currency this year. That compares to oil exporting currencies the Russian rouble, down 46 per cent, or the Colombian peso, down 20 per cent.
Yet analysts are warning that some of the emerging market currencies that seemed strongest are toppling as expectations that the US will soon raise interest rates strengthen and investors settle in for another period of dollar strength.
“This dollar move will probably pick up steam, especially if the Federal Reserve modifies its language this week, so you’ll see a lot more cracks in emerging market currencies,” says Win Thin at Brown Brothers Harriman.
Many analysts point to Turkey, which is supposed to benefit from falling oil prices but has been struggling with lower economic growth than expected and rising expectations the country will cut interest rates. The dollar is up 7 per cent against the lira this year. Yet much of that is recent — after a period of lira strength in October, the dollar has gained 5 per cent in the past six weeks.
"I struggle to see a client who is long dollar-Turkey — including ourselves,” says Luis Costa, an emerging market currency analyst at Citigroup.
“The lira had good carry, with energy prices helping out massive importers of energy and it worked out nicely but we could be in an environment here where this is starting to crack.”
The Mexican peso, long seen as a haven of stability among emerging markets investors, is also coming unstuck.
The currency has dropped by more than 10 per cent since the end of October to 14 per dollar — a level not seen since the financial crisis. The pace and intensity of the sell-off have left many analysts dumbfounded given Mexico’s relatively strong fundamentals.
Projected growth in Mexico’s economy
Indeed, with the US as its biggest trading partner, Mexico is arguably best placed to benefit from the recovery of its northern neighbour. Even though growth has consistently undershot expectations this year, Mexico’s economy — which is projected to grow between 2-2.5 per cent in 2014 — remains the envy of the region.
Among big oil producers, it is also seen to be the least affected by the slide in crude prices thanks to a strong manufacturing export sector and shrewd oil hedges.
Instead, analysts say the peso is a victim of its easy tradability. As the world's eighth most-traded currency, the Mexican peso is often used by investors as a proxy for less liquid EM currencies. By contrast, currencies such as the Brazilian real are far less liquid because regulations and controls make it much harder for investors to get in and out quickly.
“The peso has historically had a high correlation with risk given that it is the most liquid currency in Latin America,” says Sireen Harajli, FX strategist at Mizuho Bank. “This makes it vulnerable to large sell-offs during times of stress as a hedge against long positions in EM.”
The sell-off is being exacerbated by the high level of foreign ownership of Mexican local bonds.
“Foreign investors holding local bonds have been trying to hedge their risks by buying dollar forwards to protect themselves against further depreciation,” says Daniel Tenengauzer, head of emerging markets research at the Royal Bank of Canada.
Ultimately, the peso’s decline needs to be put into perspective, says Marco Oviedo, analyst at Barclays.
“If the weight followed the same behaviour as the yen, the real or the euro, should be at 17 pesos per dollar,” he says.
But with the market firmly in a risk-off mode at the moment, he expects the peso to continue to come under pressure in the weeks ahead.
The Indonesian rupiah, another top-performing emerging market currency this year having lost only 4 per cent against the dollar, is also showing signs of cracking. The rupiah was up on the year against the dollar at the end of October but on Monday it hit a 16-year low. Mr Thin at Brown Brothers Harriman warns that there is now “too much good news priced in” on the political front in Indonesia, after a new president was swept into power on a wave of hope for reform in July.
Despite the capitulation of some of the stronger EM currencies, however, analysts say the search by investors for divergence is still on. The Indian rupee, which is flat on the year thanks in part to India’s status as an oil importer, is seen as one remaining pillar of strength.
Others may have fallen too far, too fast, making them arguably ripe for a rebound. These include the Russian rouble or the South African rand. Yet with the oil price continuing to fall and investors wary of risky bets at the end of a tumultuous year for currencies, analysts admit it would be foolish to call a bottom in any battered EM currency just yet.