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Emerging market currencies are on track for their worst first half since 2020, pushed down by an unexpectedly strong dollar and easing in a popular trading strategy in Latin American markets.
JPMorgan’s emerging market currency index has fallen 4.4 percent so far this year, more than double the decline seen in the same period in the previous three years. The move came as investors dashed hopes of a quick U.S. interest rate cut in 2024 and nerves over weakening economies and expansionary fiscal policy pushed currencies lower in some major emerging markets.
“It’s a combination of a more resilient economy in the US and, on the emerging market side, emerging markets like Chile, Hungary and Brazil continue to cut rates,” said Luis Costa, global head of emerging market strategy at Citigroup.
“And let’s be honest, the outlook for growth in EM is not great for this year and next year – global trade is steadily declining and it’s a very complicated election year,” he added.
Much of the recent weakness has come from the unwinding of so-called carry trades, where investors profit from differences in returns between currencies. The trade was popular with emerging market investors earlier this year.
But especially in larger emerging markets, these deals have run into trouble as the election has caused more volatility in assets and the future development of local interest rates has also become less clear.
The recent weakening of the Mexican peso was “an example of the unwinding of a sizeable foreign currency trade that had previously been building for two years, from mid-2022 to the end of May 2024,” JPMorgan analysts said this week.
The Mexican peso has fallen nearly 10 percent since the country’s ruling Moreno party won a landslide victory that raised concerns about fiscal policy in Mexico and increased intervention in the economy. Investors say the effects have spilled over into other Latin American currencies, such as the Colombian peso and the Brazilian real.
“LatAm’s currency has been most responsible for the recent weakness – it was kicked off by some policy changes, but there was a very heavy position in some of the higher carry currencies, which caused the whole trade to unwind,” Grant said. Webster, a portfolio manager at investment firm Ninety One.
Some investors have been moving from larger markets such as Brazil to smaller, poorer economies emerging from periods of turmoil where they believe politics, including high interest rates, still make bets on local currency bonds attractive, such as Nigeria and Egypt.
Asian currencies, which are among the most affected by China’s weak economy, have also struggled this year. The South Korean won fell 7 percent against the dollar, while the Thai baht and Indonesian rupiah both fell 6.5 percent.
Currencies around the world have struggled this year to perform against the dollar, which is 4.5 percent higher against a basket of six major currencies after strong U.S. economic data and sticky inflation forced a major reassessment of the interest rate outlook.
Investors are now betting on two rate cuts by the Federal Reserve this year, up from six or seven at the start of the year.
“Just over half of the EM weakness was due to dollar strength,” said Kieran Curtis, emerging markets portfolio manager at Abrdn. “At the beginning of the year, investors thought there might be six or seven [US] A rate cut this year – and there can be none now.”