It’s been a rough and volatile year for emerging market currencies, some of which like the Brazilian real have slumped to record lows. Going into the third and final quarter of the year, investors are expecting the weakness to continue and things to get worse before they get any better. Here’s why:
The Fed: Will They/Won’t They?
“We’ve been waiting a long time, perhaps as much as six years, wondering when the Fed is going to do something about interest rates, and it’s always just around the corner,” said Bryce Fegley, portfolio manager of the Saturna Global High Income fund.
The market is still expecting a rate hike, albeit a tiny one, but the continued uncertainty over when that is going to happen continues to create volatility and put downward pressure on emerging market currencies.
Strong Dollar a Key Factor
The eventuality of a hike has parlayed into a strengthening of the U.S. dollar and that, of course, impacts the value of emerging market currencies.
“The closer a rate hike gets, the more effective the dollar looks from an interest rate perspective because we can have marginally higher rates on savings here,” Fegley said. “If at the same time you have weakness in the Eurozone, in Latin America and in Asia, then it appears there’s a differential on what you earn on savings in real rates, so this has driven the dollar strength.”
Looking beneath the surface, though, the dollar had actually weakened consistently compared to other currencies, peaking in 2011 and 2012, Fegley said, while emerging market currencies were at the time driven higher by trade flows from China and demand for resources, “so much of their current weakness stems from dollar overvaluation and resource demand.”
Continued Capital Outflows
Emerging markets have been heavily reliant on foreign capital for growth and as capital has been flowing out of these economies their currencies have weakened, said David Spika, global investment strategist at GuideStone Capital.
“I think that to see currencies stabilize, we are going to have to see better growth in emerging markets, but I don’t see that happening anytime soon,” he said.
China Slowdown Has an Impact