US yields set to tighten grip on emerging-market currencies
Slowing economic recovery amid a resurgent pandemic is leaving emergingmarket currencies vulnerable to a selloff if Treasury yields rise again.
While the influence of US borrowing costs on developing-nation currencies has waned in recent months, it may return to prominence for riskier assets as the cushioning effects from China's growth rebound and low inflation weaken, according to money managers, including Fidelity International and Credit Agricole CIB.
"A very sharp, quick move higher in front-end US real yields would be an extremely bad outcome for emerging-market currencies," said Paul Greer, a money manager at Fidelity in London, which oversees about $700 billion. "Gyrations on the US rates curve, particularly in the real-yield space, will remain the dominant driver of sentiment in the very near term."
Emerging-market currencies got a glimpse of the
Treasury-led turbulence last week, when they posted the biggest loss since July 9 as the two-year yield jumped. The pain could deepen if key economic data, including China's industrial production and South African consumer prices, confirm forecasts for a worsening macro picture.
Beyond this week's reports, traders' big cue on the direction of Federal Reserve policy may come from the Jackson Hole symposium later this month.
The benchmark gauge for emerging-market currencies has fallen about 2 per cent from a record in June and is on the verge of erasing its gains this year. While its 120-day correlation with the US two-year yield is holding near zero, meaning they're moving independently of each other, money managers caution against complacency.
The dwindling correlation comes after Treasury yields softened in the past two months. Even though lower US rates encouraged investors to seek higher yields, emerging-market exchange rates failed to benefit amid concern the highly infectious delta variant of Covid-19 would hamper domestic growth.
"Growth and liquidity might actually be the fiercest headwinds in the second half and also explain why falling U. yields didn't buoy EM currencies in July," said Witold Bahrke, a senior macro strategist at Nordea Investment. "The mediumterm outlook on EM currencies is primarily being determined by a trifecta of yields, growth dynamics and liquidity."—Bloomberg