Currencies suffer worst day in a year on upbeat dollar, US bond yields

An index of emerging market currencies on Monday looked to post its biggest drop since a pandemic-induced slide a year ago, as rising US Treasury yields lifted the dollar and dulled appetite for risk assets.

MSCI's index of developing market currencies slid 0.8% with China's onshore yuan slipping 0.4% to turn negative on the year, while Turkey's lira dropped 2% to its lowest in almost three months.

South Africa's rand, Brazil's real and Mexico's peso all weakened more than 1% against a surging dollar.

"Last weeks leg higher in US breakevens precluded real yields from jumping beyond -60 basis points, but the 40 basis point move over the past month or so clearly did not go unnoticed by EM FX and fixed income assets," said Luis Costa at Citi.

The dollar hit its highest since late-November against a basket of major rivals the as yields on US Treasuries climbed to multi-month peaks following the passage of a $1.9 trillion fiscal aid package by the US Senate and strong payrolls data on Friday.

The emerging market currency index is down 1.3% year-to-date with gains made on optimism from a faster global recovery and vaccine rollouts being undone by fears of a likely pick up in inflation.

The latest moves prompted a number of big banks to shift their stance on emerging currencies.

Morgan Stanley strategists downgrade their view on EM currencies for the second time in as many weeks, predicting the sell-off would continue across local debt markets and credit.

"We expect the weakness to be fairly orderly, given the global recovery cycle, with EMFX weakening by 4-5%," said strategist James Lord in a note to clients.

However, he did voice concerns about deteriorating fiscal balances and slow progress in containing the COVID-19 outbreak in many developing economies.

JPMorgan's local currency debt index has returned -5.4% since the start of the year, while hard-currency debt benchmark is down 4.6%, according to Refinitiv data.

Turkey's lira, which suffered a near-double digit loss over the past 11 sessions, has once again caught the limelight.

Citi and JPMorgan expect Turkey's central bank to hike rates by as much as 100 basis points in March to help keep inflation pressures in check. As crude prices surge, a depreciating lira spells further bad news for the oil importing country's economy.

In thin trading, crude producer Russia's rouble fell up to 0.3% in the interbank market, giving up gains made on rising oil prices. Trading on the Moscow exchange was closed on Monday for a holiday.

Stocks in the developing world sank 1.7% to a two-month low. The EM equity index was pulled sharply lower by a 3.5% fall in China mainland stocks - their worst tumble in around eight months.

Turkey's main stock index fell 0.6% after four straight days of gains, while the South African benchmark lost 0.3%. Brazil's Bovespa lost about 1.7%.