A surging US dollar and a “confluence of bad news” have sparked the biggest sell-off in emerging market currencies since the early stages of the Federal Reserve’s aggressive rate-raising campaign two years ago.
A JPMorgan index of EM currencies has fallen more than 5 per cent over the past two-and-a-half months, putting it on course for its biggest quarterly decline since September 2022.
The decline has been broad, with at least 23 currencies tracked by Bloomberg falling against the dollar this quarter.
The greenback has been on a tear since late September as one of the most prominent so-called “Trump trades”, fuelled by expectations that US president-elect Donald Trump will impose sweeping trade tariffs and loosen fiscal policy when he takes office next month.
“The dollar is absolutely front and centre” as the driver of weakness in EM currencies, said Paul McNamara, lead manager on emerging market bond and currencies at fund firm GAM.
Trump announced last month he would impose levies of 25 per cent on all imports from Mexico and developed market peer Canada, along with an additional 10 per cent on Chinese goods. The Mexican peso has fallen 2.1 per cent this quarter, while China’s offshore renminbi is down 3.7 per cent.
More broadly, the South African rand — usually seen as a proxy for sentiment across EMs because it is easier to trade than other currencies — has fallen about 2.4 per cent since the end of September.
Even when the interest earned from holding assets in a local currency is factored into foreign exchange returns, only the currencies of countries considered very risky by investors, such as Turkey and Argentina, were in the green for investors this quarter.
The breadth of the post-election sell-off has also hit so-called carry trades, when investors borrow in lower interest rate currencies such as the dollar or yen to buy the higher-yielding EM currencies.
A basket of popular EM carry trades tracked by Citi has returned only 1.5 per cent this year, or roughly its 10-year average, versus 7.5 per cent in 2023, the US bank said.
EM currencies last posted a quarterly decline of this scale in 2022, when the Fed turned the screws on monetary policy to curb runaway inflation. As US interest rates leapt higher, the widening gap with rates in EMs piled pressure on those countries’ currencies.
The latest fall puts JPMorgan’s EM currency gauge on course for its seventh annual decline in a row.
Analysts said weakness in the Mexican peso could be attributed in large part to tariff developments. But the picture is more complex for a number of other EM currencies, with some also coming under pressure from country-specific challenges, they added.
“There’s been a confluence of bad news in the emerging markets,” said Thierry Wizman, global foreign exchange and rates strategist at Macquarie.
He highlighted China, noting “concerns about the slump in the domestic economy [and] the prospect that the central bank is going to continue to ease policy”, and Brazil, citing “concerns about deficits and debt sustainability”.
Yields on China’s benchmark 10-year bonds have fallen below 2 per cent to their lowest level in 22 years, as traders bet the central bank would cut interest rates further to help stimulate growth.
Brazil’s real has also fallen to record lows in recent weeks, breaking through the threshold of six to the dollar for the first time as a new government promise to find R$70bn (US$12bn) in cost savings did little to soothe worries about its public finances.
“Brazil has a fiscal crisis on its hands,” said Ed Al-Hussainy, global rates strategist at Columbia Threadneedle Investments.
“Mexico has exceptionally low levels of productivity, growth and investment for an economy that is America’s largest trading partner,” he said, while there are also issues with the quality of its constitution and its institutions following recent judicial reforms.
While noting EMs in general “have not been attracting capital flows”, he added that “all these countries have some idiosyncratic issues and what’s striking is very few of those idiosyncratic issues are positive”.
Meanwhile, South Korea’s won was hit after President Yoon Suk Yeol declared martial law — a decision he later retracted.
The surging dollar has also pushed the euro lower in recent months. This, according to Mark McCormick, head of FX and EM strategies at TD Securities, is bad news for EM currencies that “orbit the euro”, including the Polish zloty and the Hungarian forint.
Macquarie’s Wizman said the sell-off in developing market currencies had helped revive the so-called “Tina” investment narrative — that there is no alternative to investing in the US.
“There aren’t any emerging markets these days that stand out as having robust economic stories,” he added.
Additional reporting by Joseph Cotterill in London