Emerging Currencies Head South

Currencies head for worst month since August 2015 on imminent rate hike

Emerging-market currencies and bonds reacted sharply to the imminent interest rate hike by the U.S. central bank on May 31st, 2016, plunging to levels last seen in August 2015, and wiping out monthly gains on falling demand. The currencies of both South Korea and China weakened as the Bloomberg Dollar Spot Index extended its biggest monthly advance since September 2014.

Janet Yellen, Federal Reserve Chairperson, hinted at a hike in interest rates in the coming months following a slow and steady uptick in the U.S. economy on Friday, May 27th, 2016. The Fed Chairwoman has earlier stated that it was appropriate for the Fed to gradually increase interest rates over time. The Federal Open Market Committee (FOMC), which last hiked interest rates in December 2015, is meeting in Washington on June 14-15, 2016, to debate on the possibility of a second interest-rate hike.

Market reaction after imminent Fed rate hike

The Fed rate hike possibility had an adverse impact on 10-year Treasury futures contracts on May 30th, 2016, triggering its biggest decline since May 18th, 2016, based on data supplied by the Chicago Board of Trade and as reported by Bloomberg.

The MSCI Emerging Markets Currency Index declined 0.4% and was down 3.1% in May 2016, the biggest drop since August 2015, reversing three months of gains. Fixed-income markets, which also felt the after effects of Yellen’s speech, joined the regional slide in currencies. Bonds in developing countries are likely to see lower demand when the Fed hikes interest rates in June 2016. The MSCI Emerging Markets Index fell 0.2%, taking May’s drop to 4%, the worst since January 2016.

While a global recovery sounds promising, experts feel that the rising U.S. interest rates could divert funds away from emerging markets. Added to this, the threat of China’s economic slowdown could pull down emerging markets to a low as seen in January 2016.

The uncertainty revolving around a possibility for one to two U.S. rate increases this year, along with the risk that the U.K. could exit the European Union, could result in a slide in emerging-market currencies and bonds in the near-term. On the other hand, some analysts feel that markets are starting to look more bullish since a better U.S. economy would drive global growth.

Rising dollar proves a threat

The greenback rose against most of its Group-of-10 counterparts following Yellen’s hint at an interest rate hike in the coming months. Bullish bets on the greenback jumped the most since November 2015, switching to a net-long position, as per Commodity Futures Trading Commission and as reported by Bloomberg.

Source: Bloomberg, Commodity Futures Trading Commision
Source: Bloomberg, Commodity Futures Trading Commision

Yen drops on tax delay talks

On Monday, May 30th, 2016, the yen fell to a one-month low versus the dollar after Japanese Prime Minister Shinzo Abe’s aide said that Japan needs to delay a sales-tax hike scheduled for 2017, in a bid to sustain economic growth, as reported by Bloomberg. Japan’s currency was the biggest loser among the emerging nation currencies as slow retail sales increased the likelihood that Abe will delay the tax increase.

Japan’s economy grew by an annualized rate of 1.7% in the January-March 2016 period, higher than a median market forecast of a 0.2% growth, according to Japanese Cabinet Office data and as reported by Reuters on Wednesday, May 18th 2016. The rebound in Q1 2016 paved the way for Prime Minister, Shinzo Abe, to delay a sales tax hike until 2019, on June 1st, 2016. The move, along with the government’s proposed stimulus package of 5-10 trillion yen ($45-$90 billion), may help support consumer spending, but would not enable the government to rein in debts.

With the current turmoil in the financial markets, one can only hope that emerging economies remain resilient in the face of a crisis.

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