After suffering since 2013 following the “taper tantrum” when the Fed announced the wind down of asset purchases and through the start of this year as the Fed warned of additional interest rate hikes, emerging market (EM) currencies have logged their strongest monthly rally on record in March, according to Bloomberg’s calculations.
As the dollar fell with softer U.S. data and a dovish Fed attitude, EM currencies — which had been severely battered by the lingering weakness in commodity prices, capital outflows, and local policy shortcomings — rallied hard in March with the Bloomberg EM currency gauge gaining 6.3 percent, the highest monthly gain on record, beating the previous record of 5.5 percent in February 1998.
Bloomberg’s U.S. currency gauge posted its steepest monthly decline since 2010, on the Fed, which thus fueled the record rally for EM currencies.
The Federal Reserve has (aside from losing all credibility) adopted what it calls a “gradual approach” to its interest rate-increase cycle, thus fueling optimism that capital inflows can be sustained, and Janet Yellen has said that policy makers would act “cautiously” as they look to hike rates.
“Yellen’s comments were pretty aggressive and make it clear that rate hike expectations might as well be scratched out for this year,” said Nathan Griffiths, a senior emerging-market equities manager who helps oversee $1.1 billion at NN Investment Partners in The Hague told Bloomberg.
“This is the perfect backdrop for emerging markets to continue” the rally because positioning remains geared to a rising dollar, he said.
Such dovish attitude from the Fed has ‘aligned the stars’ in EM markets, as one strategist said:
“The stars are aligned for EM currencies right now,” said Per Hammarlund, the chief emerging market strategist at SEB told Bloomberg.
“They were long overdue for a correction, as valuations in many emerging markets had become very attractive. In addition, concerns over China have eased. The Fed has turned more dovish over the past two months.”
EMs saw investment inflows reach a 21-month high of $36.8 billion in March, the strongest month since June 2014, with Asia leading the way, according to the Institute of International Finance (IIF).
— IIF (@IIF) March 30, 2016
“In the absence of much improvement in the fundamental economic outlook for EMs, it appears that March’s surge was mainly due to a global risk-on shift in investor behavior and lower mature market interest rates, supported by surprisingly dovish signals from the FOMC on March 16,” the IIF said.
In addition to EM currencies, EM stocks also rallied in March with the benchmark MSCI Emerging Markets Index gaining 13 percent, the most since May 2009, according to Bloomberg data.
Here is a look at the recent EM rally as we compare two popular EM ETFs.
First, lets look at EM stocks and the iShares MSCI Emerging Market Index ETF (EEM):
Second, we look at EM currencies and the WisdomTree Dreyfus Emerging Currency Fund ETF (CEW):
EM Currencies Versus the Almighty Dollar
One of the key factors associated with the recent spike in EM currencies was the current weakness in the dollar, due to the lowering of rate hike expectations.
But the dollar remains strong in comparison to EM currencies.
To illustrate, below is a chart of the dollar versus select EM currencies compared over a span of five years.
The dollar started appreciating in 2011, but as the chart clearly shows over a five year span, EM currencies are still rather weak.
The Indian Rupee is about 48 percent weaker, Indonesian Rupiah about 52 percent weaker and currencies such as the Brazilian Real and South African Rand are weaker by more than 120 percent.
EM assets in dollar terms are still pretty weak, but yet offer an enviable yield, however EM optimism is only limited and temporary, renewed market volatility remains ahead, as any fresh hints from the Fed on the tightening of monetary conditions will push investors to race for the exit from EM.
As the global economic slowdown led by China deepens and global Central Banks increasingly run out of ammo, the key question is — what lies in store for markets in the longer-range scope down the road?
Dark storm clouds are gathering, be cautious and have a plan.