Will the Fed kill the EM currency rally, or will Trump?

| 01-11-2016 | Simon Knappstein |

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The USD is strengthening again broadly across the range. As it had weakened since Q1 this year versus EM currencies, this trend now seems to have come to a halt. Obviously the expectation that the Fed will almost certainly raise interest rates in December is the major factor for this move. What also may be of importance here is the nascent notion that the expansion in global liquidity that has characterized financial markets for so many years might have come to an end. Both the ECB and the BoJ seem less willing and/or have less room to increase QE.

 

This tends to direct investment flows away from EM currencies, and to a lesser extent from EUR and JPY, into the USD. So expect a stronger USD into year-end. And possibly even more in case of a Trump win, as protectionism will hurt global trade and that will hurt other currencies more than the USD. According to ING MXN, CAD, GBP and AUD would be among the currencies that would be hurt most relatively.

Here is a summary describing the consensus-view on a number of currencies. You can find more information and details on consensus FX forecasts in my latest October report.

Developed Markets

The Fed appears set to raise rates again before 2016 comes to a close. The USD is strengthening broadly; expect this to continue in the run-up to year-end. The USD is likely to peak when rates are finally lifted again in December. With a Fed hike likely to come before year-end and questions regarding Eurozone bank stability looming, the outlook for the common currency is becoming slightly bleaker. Over the remainder of the year, the EUR is likely to fall out of favor with investors.

For GBP, the likelihood of a so-called ‘hard Brexit’ has increased. Such a scenario increases the chances for another rate cut by the BoE during the remainder of this year. Expect downside pressure to prevail for the next couple of months. Oil prices boost the CAD, but still the outlook for a weaker CAD near-term hasn’t changed.

The JPY is not weakening on BoJ measures; only USD strength is pushing USD/JPY higher. External factors are the main drivers for JPY weakness. Stronger-than- expected commodity prices are the major factor keeping the AUD elevated. A weaker AUD looks more likely from here.

Emerging Markets

The RUB seems less sensitive to oil price shifts. High carry is providing support in risk-on circumstances. TRY has weakened on capital outflows on the back of a ratings downgrade. Geopolitical risks will weigh further on the TRY.

Latam

The BRL continues to trade with a positive momentum on the back of fiscal reforms by the interim president Temer and also by a high carry. The MXN has proven vulnerable to portfolio outflows. Rate hikes have given little support. A Trump win might push USD/MXN above 21.

Asia

CNY is weakening against the USD as the Fed is expected to raise rates. PBoC will verbally support the CNY but depreciation trend will continue. INR looks stable through the transition to a new RBI Governor. Still supported by a relatively high carry.