Emerging Markets (EM) currencies have suffered a sharp sell-off over the past month, down around 4% year-to-date against the US dollar and even more compared with the strongest levels of late January.
What is driving investors’ EM jitters, and could they escalate into a larger EM crisis?
In a new research piece, Nordea Markets analysts Anders Svendsen, Morten Lund, Amy Yuan Zhuang and Tatiana Evdokimova take a deep dive into the main factors behind the EM FX sell-off and what to expect going forward.
The US dollar is the single most important benchmark for EM FX sentiment, and the stronger dollar is the most obvious near-term risk to EM currencies. As the dollar strengthens, the cost of servicing dollar-denominated debt rises in many emerging economies.
But even aside from the stronger dollar, the list of potential additional external shocks to EM sentiment is quite long:
- Rising US government bond yields could add to the weakness in EM, especially if driven by higher wage growth or a hawkish shift at the Fed rather than positive growth surprises.
- Falling commodity prices could also add fuel to the fire, which was the case with the collapse of commodities prices from the second half of 2014.
- Liquidity contraction from major central banks could have a massive impact on risky assets in general over the medium term and on EM in particular.
- Global growth is generally strong, but momentum has been slowing in recent months. A more pronounced slowdown in high-frequent activity indicators would add to the general concerns about EM.
- Geopolitical risks from trade war to sanctions
Get all the details in the full report: “EM FX: USD shock and rising risks”
And take a look at our Emerging Markets Traffic Light, which estimates the risk of extreme pressure on 33 individual EM currencies within the next six months based on nine fundamental indicators. 9 of 33 EM currencies are assigned a yellow warning light, which means that the risk of extreme pressure is more than 20%. Moreover, the general EM risk level is rising and is no longer below the levels from before the taper tantrum in 2013.
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