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Flexing safe-harbor status, dollar 'wrecking ball' for some emerging currencies

A wide range of emerging market currencies fell in September after five months of relative strength as renewed COVID-19 lockdowns, a bumpy global growth recovery and uncertainty surrounding the U.S. presidential election revived safe-harbor demand for the U.S. dollar.

Only four of the 21 emerging market currencies tracked by S&P Global Market Intelligence posted monthly gains in September. "The USD has become a virtual wrecking ball over recent sessions, with the strength finally beginning to impact emerging market currencies more heavily," John Hardy, head of foreign exchange strategy at Saxo Bank, wrote Sept. 24.

The Dollar Index, which tracks the currency against a basket of developed-market peers, increased 1.9%.

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Mounting growth anxiety amid a second COVID-19 wave and uncertainty about further U.S. fiscal stimulus have dampened emerging market sentiment, according to Robin Brooks, chief economist of the Institute of International Finance and former chief FX strategist at Goldman Sachs.

In addition, election-related risk has increased and is weighing on currencies, Brooks tweeted in the week of Sept. 20, when the MSCI International Emerging Market Currency Index fell 1.3%, marking its worst week since mid-March.

The MSCI International Emerging Market Currency Index, which reflects the performance of 26 emerging market currencies relative to the U.S. dollar, rose 0.4% in September, the weakest performance since currencies began their rebound from a four-month slump that began in January. Because of the index's weighting, gains by currencies tied to large East Asian economies pulled up the average while most index components lost ground.

The South Korean won was the best performer in September, with a 1.5% rise. The Taiwan dollar and Chinese yuan increased 1.4% and 1.1%, respectively.

"Based on fundamentals, emerging Asian currencies — notably [the yuan, won, Taiwan dollar and Thai baht] — appear to be viewed most positively among EM FX analysts, with a cyclical recovery generally anticipated, given that public health situations are now largely under control," Natalie Rivett, senior emerging market analyst at Informa, wrote in early September.

The Turkish lira was the worst-performing currency for the second straight month, slumping 4.9% and again hitting fresh lows.

The currency failed to sustain gains that followed the central bank's surprise interest rate hike of 200 basis points, as it faced renewed negative pressure due to the risk of a proxy war between Turkey and Russia over the disputed Nagorno-Karabakh region, which saw tensions escalate in late September.

"[T]he risk that Turkey may be dragged into yet another foreign conflict is likely to weigh on Turkish assets for now," strategists at TD Securities wrote Sept. 28.

The Russian ruble fell 4.4% in the month as the recent hostilities and prospects of former U.S. Vice President Joe Biden's victory in the Nov. 3 presidential election hurt the currency.

The Democratic challenger is seen "far less friendly" to Russia than President Donald Trump, according to Hardy of SAXO Markets.

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In the third quarter, the lira and ruble were the biggest laggards among emerging market currencies, with losses of 11.2% and 8.3%, respectively. Year-to-date through September, the Brazilian real and lira were the worst performers, plunging 28.5% and 22.9%, respectively.

"Some EM countries have put fiscal discipline to one side, which has put pressure on their currencies," Quentin Fitzsimmons, portfolio manager at T. Rowe Price, wrote in a Sept. 23 note.

Looking ahead, the U.S. election and the global growth recovery are expected to continue shaping the direction for emerging markets.

"[I]t may be the case that EMs are entering a period of weakness or at very least, consolidation as investors take some risk off the table heading into the looming key risk event that is the U.S. presidential election," Rivett wrote Sept. 29.