The emerging market currencies most at risk of further falls

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  • The MSCI emerging markets currency index has fallen by 8.5% from its 2018 highs.
  • Capital Economics said EM economies with a current account balance are most at risk of further declines.

When it comes to the outlook for emerging market currencies, look to the balance of payments.

Capital Economics says the currencies of EM economies with a current account deficit will be more susceptible to further falls in the months ahead.

Officials from Turkey and Argentina have been scrambling to prop up their respective currencies in recent weeks, as markets assess possible contagion risks from EM exposure.

And CE’s Oliver Jones says the Turkish lira and Argentian peso fall into the group of EM currencies that are more at risk.

Since the US dollar commenced its uptrend in April this year, the MSCI’s emerging market currency index has fallen by around 8.5%.

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But the broader fall “hides the fact that EM currencies have weakened in two fairly distinct groups,” said CE’s Oliver Jones.

In the first group are currencies which are more exposed to a reduction in US dollar liquidity, as the Federal Reserve continues to raise rates and withdraw monetary stimulus.

“Aside from the Turkish lira and Argentine peso themselves, this group not surprisingly contains the currencies of other EMs with relatively large current account deficits,” Jones said.

“Notable examples include the Indonesian rupiah, South African rand and Indian rupee, all of which are amongst the most highly-correlated EM currencies with the Turkish lira.”

In contrast, there’s another group of EM currencies which have been more resilient to the Fed but instead have come under pressure from the US-China trade war.

“This is because the issuers of these currencies mostly have current account surpluses, and trade a lot with China,” Jones said.

“The main examples are the Thai baht and Korean won, which have both tracked movements in the Chinese renminbi closely.”

Capital Economics

According to Jones, the near-term outlook isn’t great for either group. The US Fed will press ahead with more rate rises, while markets are braced for the Trump administration to impose another $US200 billion of tariffs against China.

Looking ahead to 2019, Jones said the first group of currencies is susceptible to further falls, because a slowdown in the US economy will reduce risk appetite.

“But the second group should do better, especially if China‚Äôs economy and the renminbi stabilise, as we anticipate,” he said.

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