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US 'blue wave' prospects lift emerging currency index to best month since July

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US 'blue wave' prospects lift emerging currency index to best month since July

A broad index of emerging-market currencies regained momentum in October as prospects of a White House and Congress sweep by the U.S. Democratic Party fueled market expectations that the next U.S. government will pass a major coronavirus stimulus package and take a less aggressive trade stance.

The MSCI International Emerging Market Currency Index, which reflects the performance of 26 emerging-market currencies relative to the U.S. dollar, climbed 1.3% in October, the largest gain since July. The index is most heavily weighted in currencies of major East Asian economies, which pulled up the index components' average.

Nearly half of the 21 emerging-market currencies tracked by S&P Global Market Intelligence traded in the green in October following a broader-based selloff in September. The Mexican peso and South African rand led the rally, rebounding about 4% and 3%, respectively, while some Asian currencies sustained monthly gains.

The Mexican peso, which rose nearly 4% in October; South African rand, which gained almost 3%; and Chinese yuan, which rose 1.5%, may stand out as the primary beneficiaries of a Joe Biden presidency, which is considered a "more favorable outcome" for emerging-market currencies as a whole given his "less confrontational approach on tariffs," according to FX strategists at J.P.Morgan.

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Biden's less aggressive trade stance would also bode well for some of the yuan's Asian peers, with trade-oriented currencies such as the South Korean won, Singapore dollar and Taiwan dollar reaping most of the benefits, strategists at TD Securities wrote in an Oct. 26 note. The won and Taiwan dollar gained 2.5% and 1.2%, respectively, in October.

"In a Biden-led government, EM FX would likely appreciate. ... A blue wave is likely to usher in a more multilateral approach to U.S. policy, result in stronger U.S. stimulus, and be supportive of EM assets," the strategists said.

Conversely, a Republican sweep of the presidential and Senate elections would strengthen the safe-harbor U.S. dollar and put pressure on most emerging-market currencies, TD Securities added. A split government or divided Congress resulting in a smaller fiscal stimulus is also expected to hurt emerging markets.

In October, the Turkish lira tumbled 7.9% to become the worst-performing currency for the third consecutive month, touching new lows after the central bank defied market expectations for another large policy rate hike.

The lira and the Russian ruble, which fell 2.1% last month, are likely to become outliers among rallying emerging-market currencies in a Biden-win scenario, according to TD Securities.

"If Biden wins the presidency, the U.S. may reengage differently in the Middle East and [Eastern Mediterranean] affairs and put both Russia and Turkey, for different reasons, under much closer scrutiny and possible review for sanctions," the strategists wrote.

The Argentine peso was the second-weakest currency in October, dropping 2.8%, while three other Latin American currencies also traded in the red.

Over the final months of 2020, emerging-market currencies are expected to rally due to prospects for emerging markets' growth recovery and a coronavirus vaccine, in addition to the possibility of a "blue wave" election, analysts at Morgan Stanley said, noting that they were going "all in" on emerging currencies.

"The risk/reward in EM at current levels looks attractive to us, particularly since betting markets appear to be underpricing the probability of a Democratic sweep relative to what the polls are indicating," the analysts wrote in an Oct. 24 note.