Following Wednesday’s FOMC monetary policy releases which saw the Fed’s ‘dot plot’ projections for further rate hikes in the year ahead severely pared, analysts have been assessing the potential impact of a dovish Fed on EM currencies.
2018 saw policy divergence maintain a stranglehold on EM’s as the Fed continued to hike and signal future hikes, however, the shift away from hawkish into the new year has allowed several EMs to begin to claw back last year’s losses with expectations that s soft Fed will allow EMs to extend gains further. Wednesday’s Federal Open market Committee (FOMC) policy meeting and subsequent press conference saw Federal reserve Chairman, Jerome Powell, reiterate his intention to remain “patient” with regards to policy while median projections for interest rates saw December’s projection of 3 cuts (2 in 2019 and 1 in 2020) cut to zero hikes.
Head of FX strategy at Westpac, Richard Franulovich, wrote “Markets were universally poised for a very benign outcome and the Fed dutifully delivered, their message overall matching the most dovish of expectations… The median 2019 projection is for no hikes, a strong majority of 11 among 17 at zero; a dramatic shift from just two members looking for no Fed hikes in 2019 back in December.” CBA senior currency analyst, Joseph Capruso, added “The more cautious tone and downgraded U.S. economic outlook will limit dollar upside.”
For emerging markets, the softer Fed will come as a relief and is expected to prompt an inflow of investor capital with the trend anticipated to accelerate as the year goes on, with the caveat that the Fed remain hobbled.
Commenting on the expected flow of capital into EMs, currency analyst, Jameel Ahmad, wrote ” This will stretch across the likes of China, South Africa and Saudi Arabia. We should also not discount the momentum that emerging market currencies should be able to build, when we consider that many of the currencies belonging to the developing world remain significantly weaker than where they were valued in the time before the Fed started monetary tightening four years ago.”
Looking at specific currencies, Ahmad added that he is particularly upbeat on the “Indonesian Rupiah (IDR), Chinese Yuan (CNY) and Malaysian Ringgit (MYR) as a result of the dovish Fed message,” before adding “The Singapore Dollar (SGD) will also be encouraged by a softer Greenback, while the South Korean Won (KRW) will be watched after it has lagged behind its Asian counterparts so far in 2019.”
Latin American currencies are expected to reap some of the greatest rewards from downgraded US interest rate forecasts with ING analysts anticipating that the lack of Fed-induced stimulus means the US Dollar “now lacks catalysts for another persistent push higher.”
According to ING’s chief EMEA FX and IR strategist, Petr Krpata, “LatAm FX is… the best positioned to benefit given the mix of (a) dovish Fed (b) still solid US growth (c) recovering oil prices (to which the region is the most sensitive among EM FX).”
Krpata went on to highlight the Mexican currency as a potential buy against the Greenback, “The Mexican peso (MXN) will remain an outperformer, helped by the above factors as well as the attractive local bond market, as Banxico approaches the start of its easing cycle.”
Whether or not EM’s can capitalise on the softer Fed remains to be seen and will in part be dependent (especially in Asian FX) on the resolution of the US-China trade spat.
Also, aside from a few notable exceptions such as Norges Bank, there is a trend developing among central banks towards more downbeat projections of growth and interest rates which in turn could weigh on investor appetite for riskier EMs.
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