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Emerging market forex hit by trade war in August as global slowdown fears grow

The escalating Sino-U.S. trade war spilled over into emerging market currencies in August, as the Thai baht was the only one of 21 emerging market currencies tracked by S&P Global Market Intelligence to strengthen against the dollar.

The MSCI emerging market currency index slid 5.7% from the end of July. Much of that hit was taken early in the month, linked to the devaluation of the Chinese yuan as the People's Bank of China gave up its defense of seven-to-the-dollar level on Aug. 5.

In Asia, trade-sensitive currencies, including the Chinese yuan (-3.78%), South Korean won (-2.15%), Singapore dollar (-1.35%) and Taiwanese dollar (-0.74%) were all hit by an a spate of tit-for-tat tariff increases between China and the U.S.

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The economic power struggle between the world's two largest economies has hampered export-dependent economies as global trade has slowed. The volume of trade decreased by 1.4% in June, according to the CPB world trade monitor.

Weakening trade has added to concerns about a global recession and encouraged increasingly accommodative monetary policy.

"A slew of emerging market CPI readings will be released this week that support further easing in Indonesia, Thailand, Turkey, Brazil, Korea, and the Philippines," wrote Win Thin, head of currency strategy at Brown Brothers Harriman.

Latin American woe

Latin America was the weakest-performing region in August, highlighted by the continued troubles of Argentina. The peso lost 28.1% of its value, as its business-friendly president Mauricio Macri was defeated in an election poll by populist candidate Alberto Fernández.

Subsequently, S&P Global Ratings judged that the Argentinian government's efforts to extend the maturity of its debts with the IMF constituted a default, and Argentina imposed capital controls in an effort to stabilize the currency.

The Brazilian real was the second-weakest performer in July, shedding 9.1% against the dollar. The real is down 6.4% year-to-date having lost 14.4% of its value in 2018. Inflation is ticking up, with Oxford Economics forecasting it will rise to 3.5% in August from 3.2% in July. While at $9 billion in July, Brazil's monthly current account deficit was its biggest since January 2015.

"Our emerging market [foreign exchange] model shows the real to have neutral fundamentals, and so we expect this underperformance to ebb a bit," Thin wrote.

The Turkish lira shed a further 4.8% in August, meaning at -9.1%, it is the second-weakest performing emerging market currency tracked by S&P Global Market Intelligence in 2019 after the Argentine peso (-36.5%).

The Turkish economy contracted by 1.5% in the second quarter, and the fall in demand helped ease inflation to 15% in August, down from 16.65% in July. However, the central bank of Turkey appears set to persist in reducing interest rates, having cut by 425 basis points in July to 19.75%.

"This will leave the lira more exposed to a shift in market sentiment, which we anticipate will deteriorate on the back of growing awareness that the global economy may not avoid recession next year on the back of persistent uncertainty caused by the U.S.-China trade war," Piotr Matys, emerging markets forex strategist at Rabobank, wrote in a research note.