EM currencies to hold gains into next year as confidence in dollar wilts

JOHANNESBURG/BUENOS AIRES/BENGALURU: Most major emerging market currencies will hold gains made since March's coronavirus-driven drop into next year, supported by a weaker outlook for the dollar and hopes of domestic economic recoveries, a Reuters poll of FX strategists showed.

Foreign exchange markets in less developed countries have taken advantage of the dollar's downtrend as the US Federal Reserve signalled its willingness to keep interest rates low for a prolonged period to shore up growth, dragging down yields on US assets.

A steep dollar selloff has helped a wider index of emerging market currencies gain over 5% since hitting a three-year low in late March, an upside thrust set to continue in the near term. According to the Aug 28-Sept 3 poll of over 60 FX strategists, in twelve months South Africa's rand will have gained about 2.0% to 16.50 per dollar, the Brazilian real will have strengthened over 7.0% to 4.95 and the Russian rouble will be around 8.0% firmer at 69.5.

But the Chinese yuan and Indian rupee were forecast to trade nearly 1% lower after strengthening 5% since a year-to-date low in March. "Setting aside hedging properties, over the long run we think that EM high-yielders can eventually participate in a broad dollar-down move," noted Ian Tomb, emerging markets economist at Goldman Sachs.

"Especially if global growth and risk sentiment continue to recover, global trade policy (and US-China trade tensions) normalize, and we see further evidence of credible coronavirus management in highly affected EMs."

Nearly 70% of FX strategists who answered an additional question, 46 of 68, said domestic economic recoveries and a search for higher yield would be the primary drivers of emerging market currencies for the rest of the year.

The remaining 22 strategists cited successful vaccine trials, the US election outcome and domestic monetary policy. Most emerging market economies are expected to bounce back to growth this quarter with strong momentum as economic activity picks up due to relaxations of coronavirus lockdowns.

Analysts say more upbeat data releases in coming months would boost sentiment for risky assets across emerging markets despite overstretched local fiscal constraints. China was the world's only major economy to declare growth in the second quarter after a deep slump at the start of the year as lockdown restrictions there were eased after the country reported fewer coronavirus cases.

The yuan hovered at a 16-month high against the dollar on Thursday after the central bank lifted its official midpoint rate for the eighth straight trading day. It has yet to send any strong signal to rein in the strength of the Chinese currency.

The yuan, the most actively traded emerging market currency but also tightly managed, was predicted to weaken about 0.5% to 6.87 per dollar in 12 months' time. "We have upgraded CNY but still err on the conservative side for the near term, given political rhetoric and pressure on China in the run-up to the US presidential election," said Khoon Goh, head of Asia research at ANZ.

When asked which emerging market currencies would perform better in the remainder of the year, 28 of 65 FX strategists said commodity currencies, 26 said high-yielding ones and 11 low-yielding ones. "Much of the rebound in EM currencies is now behind us, although we think the currencies of some EM commodity exporters will appreciate a bit further this year and next as the price of oil and other raw materials recover further ground," said John Higgins, chief markets economist at Capital Economics.