Dollar’s gain is EMs’ pain

Strong dollar, firmer US yields, higher oil prices do not bode well for emerging market currencies, states report
Business Insider

Having been under pressure since early 2017, the US dollar index (DXY), has reversed course in recent months. It’s now up over 6% since mid-Feb, briefly hitting the highest level since December on Monday.


While the DXY’s recent strength reflects gains against the euro and Japanese yen, the US dollar has also strengthened against other currencies, especially those from emerging markets (EM).

According to HSBC, the greenback has recorded solid gains against all EM currencies since April 24, the day the DXY rally really took off. Rather than being about traders reversing bearish bets on the greenback, as seen in recent positioning data from the US Commodity Futures Trading Commission, HSBC says the combination of a higher greenback, higher US bond yields and strength in crude oil prices has also been a factor. “We remain cautious towards EM FX as currencies, particularly the higher yielding ones, are struggling to stabilise,” it said in a note released on Monday. “A stronger USD alongside firmer US yields does not bode well for EM FX. All the more so when we throw higher oil prices into the mix.

“This combination last occurred in November 2016 and September 2017, and EM FX also struggled versus the USD during those episodes.” HSBC notes that correlations within EM FX have risen over the past six months, which it says is a sign of building stress. “Most USD-EM pairs have been moving together in a synchronised manner recently because they are being driven by common external factors (such as tighter US monetary policy, trade tensions between the US and China, increased financial market volatility and sharply higher oil prices).

“However, it is also possible that their movements may be increasingly due to contagion risk from within.” HSBC says this contagion could be through financial channels — sentiment, global investor portfolio flows or the pricing of new bond issuance — as well as reflecting real economic linkages such as trade and tourism. “As the saying goes, a chain is only as strong as its weakest link,” HSBC says. “It is important to pay attention to what policymakers in some of the hardest hit economies are doing to alleviate the stress in their respective currencies.

“Their actions could set the tone for broader risk sentiment towards EM FX, at least temporarily.” HSBC is wary about those nations with high levels of external debt and sizable current account deficits. “We stay cautious on those EM currencies with large external funding gaps,” it says. “That said, those that have already weakened significantly and whose central banks have taken strong steps to alleviate the market’s concerns may see some temporary relief.

“It’s going to be bumpy.”