There is room for a further sell-off in emerging market currencies, warns Macelo Assalin, lead portfolio manager at ING Investment International, as
countries with large external imbalances are vulnerable to rising US yields.
Assalin, who is part of the emerging market debt local currency strategies team, highlights Turkey, India, Brazil, South Africa and Indonesia as particularly vulnerable.
“Rising US rates pose a significant additional challenge for these countries when trying to attract the portfolio inflows needed to finance their external accounts, and can also face significant outflows should market conditions worsen,” he says.
“Therefore, a further sell-off cannot be ruled out.”
Despite these risks, Assalin says the forthcoming reduction in the pace of bond purchases by the Federal Reserve in the US is “reasonably well anticipated”. He predicts that US treasury yields are likely to rise more gradually.
“In turn, some emerging market currencies that sold off aggressively on the back of the recent spike in US yields should stabilise in the near term,” he adds.
Assalin says there has been “selling pressure” in the US dollar – a result of extremely low interest rates in much of the developed world – which has triggered massive inflows into emerging markets.
As US yields increased, emerging markets have been hit by significant outflows. Assalin says this has weighed on investor sentiment, adding that demand for hedging has increased.
“In the light of the very difficult market environment and extremely uncertain backdrop, we prefer to keep risk allocation in our portfolio to a minimum,” he says. “We have very little directional exposure to [emerging market] currencies at this point, and prefer to express our views in that space through relative value trades.”
Concerns are increasing over the current shutdown in the US, the potential effects on the largest economy in the world and its knock-on effects on other markets. The US faces a technical default if Democrats in the White House and Republicans in Congress do not agree on a budget by October 17.
Clear Currency issued a market commentary by Peter O'Flanagan, head of trading, today in which it says that “as the clock ticks down, fear and uncertainty are likely to lead towards larger risk aversion during the week”.
O'Flanagan predicts that markets will remain volatile to news flow on the topic of the US shut down and major foreign exchange crosses, particularly for the dollar, have the potential for “some shock movements”.
Over the weekend, both the International Monetary Fund and the World Bank have highlighted the risks of the global environment, should US policymakers not come to some form of agreements.
As the debt ceiling in the US approaches a deadline, O'Flanagan says it is likely the dollar will strengthen against emerging market currencies.
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