Ticking time bomb under emerging market currencies
The changing of the US interest rate cycle upwards is unleashing familiar bouts of volatility in emerging market currencies, which in some cases are being undermined by domestic factors. More pain is likely to be in store for them as they adjust to a world of more expensive USDs.
There is a growing possibility of an emerging market crisis breaking out on the back of US interest rate rises. The problem has been fuelled by years of easy borrowing due to the US Federal Reserve's earlier quantitative easing programmes.
According to the Bank of International Settlements, the central bankers' central bank, to date a staggering USD 9 trillion has been borrowed outside the US from USD 2 trillion in 2000. Some USD 4.5 trillion has been borrowed by emerging market countries. It's no wonder the BIS has warned that the world is very sensitive to any changes in US interest rate policy. The underlying message is that big defaults on US loans may not be far behind, particularly from struggling emerging market countries once US interest rates start rising.
Nearly all emerging market currencies have been hit to one degree or other by the soaring USD. In many cases it is little more than a reflection of a much stronger USD.
USD/TRY – recovery potential on lower oil prices?
Some silver linings
However, for many emerging market countries the situation is exacerbated by internal factors with three countries standing out – Brazil (BRL), South Africa (ZAR) and Turkey (TRY). Brazil, which has enjoyed over a decade of spectacular growth is now reeling from plunging commodity prices, slowing economic growth and a growing scandal alleging massive corruption involving state-run oil company Petróleo Brasileiro.
Turkey also has a large current account deficit, but there are growing concerns over political interference with the actions of the central bank, which has hit TRY hard. However, out of the three, Turkey with its rapidly industrialising economy should benefit most from lower oil prices.
A silver lining for many emerging market countries is cheaper oil – Turkey and India are two beneficiaries – which is taking a lot of pressure off those with current account deficits.
Though the USD rally is in large part a divergence story between the major currency blocks, ie EUR and JPY, it may also be due to a flight to safety as a growing number of investors anticipate major debt related problems erupting in emerging market countries.
For the time being, that leaves the outlook for currencies such as TRY, BRL and ZAR as bearish.
By Justin Pugsley, Markets Analyst, MahiFX