Emerging Markets: FX risks on the rise

There's been a recent sell-off in EM currencies set against a turbulent global backdrop. Our latest report from Nordea Markets highlights what's going on.

Emerging-Markets 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 over the next six months based on nine fundamental indicators. Nine 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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