Traders who anticipated lower interest rates in developing nations are reversing course as prospects for reduced Federal Reserve economic stimulus sparks the worst rout in emerging-market currencies since 2001.
Just a month ago, central bankers in Mexico, India and South Korea were expected to pare borrowing costs at least once, according to interest-rate swaps data compiled by HSBC Holdings Plc. Now, the measures show no chance of cuts. Poland’s central bank said today that it has ended an easing cycle after lowering the benchmark rate to a record low 2.5 percent. Traders anticipate one more reduction in Hungary, instead of the two they expected a month ago.
Fed Chairman Ben S. Bernanke said June 19 that $85 billion of monthly bond purchases may end by mid-2014, helping drive this year’s 8.7 percent slide in India’s rupee and 6.5 percent drop in the Polish zloty. Weakening currencies are threatening to ignite inflation, forcing central banks in emerging markets to curtail interest-rate cuts even as their economies expand at the slowest pace since 2009.
“You’ve got this conundrum for the central banks where they are suffering from weakening growth at the same time as currency selloffs and capital withdrawals make it difficult for them to respond,” Matthew Lehmann, a strategist at JPMorgan Chase & Co., said in a June 25 interview from New York. “There’s very limited room to ease.”
Developing-country currencies tumbled an average 5.4 percent in the first half, the worst for the period since 2001, as investors pulled $32 billion from stock and bond funds in a reversal of the “monetary tsunami” that Brazilian President Dilma Rousseff said was pouring into emerging markets in March 2012. South Africa’s rand led declines, plunging 14 percent. Brazil’s real sank 8.1 percent while South Korea’s won declined 6.8 percent.
The rupee dropped 0.9 percent to 60.22 per dollar in Mumbai today, coming within less than 1 percent of its all-time low. The won weakened 0.9 percent, the most in two weeks, to 1,143.75 per dollar, while the rand lost 0.9 percent to 10.0857 per dollar as of 11:25 a.m. in New York.
Outflows from emerging markets are quickening, with investors withdrawing a record $5.7 billion from bond funds in the week through June 26 after Bernanke said he would cut back stimulus as the U.S. labor market improves, EPFR Global data compiled by Morgan Stanley show.
Growth is faltering in emerging markets just as it shows signs of strengthening in the world’s biggest economy. Developing nations expanded 4 percent in the first quarter, the least since 2009 and down from average expansion of 6.4 percent over the past decade, according to Capital Economics.
Lowering interest rates to counter the slowdown could trigger additional currency declines and drive up prices on imported products, said Steffen Reichold, an emerging-market economist at Stone Harbor Investment Partners LP, which oversees $66 billion.
“A large majority of the central banks are done,” Reichold said in a June 26 telephone interview. “They want to keep the rates steady to see how long the pressure on the currencies will last. Nobody will do anything aggressive.”
While the currency losses threaten to fuel inflation, the most recent data show consumer price increases have been easing. The annual inflation rate in developing economies fell to 3.38 percent in May, the lowest in at least two years, according to data compiled by Bloomberg. That slowdown will help allow policy makers in countries including Hungary and Mexico to reduce interest rates further, according to Credit Suisse AG.
“You can get to the point where central banks need to prioritize and stabilize the exchange rates,” Kasper Bartholdy, head of macro analysis in the emerging market trading group at Credit Suisse, said in a June 26 interview from London. “We are not there yet.”
Poland’s Central Bank Governor Marek Belka said at a press conference today that the benchmark interest rate will remain steady for “quite a few months,” following a 0.25 percentage point reduction. Poland has cut borrowing costs by 2.25 percentage points since November to fight the worst economic slowdown in four years.
Andrzej Kazmierczak, a member of Narodowy Bank Polski’s rate-setting panel, said June 21 another cut may worsen the zloty’s slump and have a “devastating impact” on bonds. The currency slid 3.4 percent against the euro in the April-to-June period, the worst quarterly drop since 2011.
In India, six-month swap rates have jumped 20 basis points over the past month to 7.47 percent, indicating traders expect the central bank to hold the rate steady through year-end, according to data compiled by Bloomberg and HSBC.
The rupee plunged to a record low of 60.765 per dollar on June 26, fanning inflation that has stayed above 9 percent for 15 straight months. The central bank said after its June 17 meeting that it needs to “be vigilant” to shifts in sentiment and capital flows.
“The rupee’s sharp fall means rate cuts will be postponed,” Arvind Sampath, Mumbai-based head of treasury at Fullerton India Credit Co., owned by a unit of Temasek Holdings Pte., said in a phone interview on June 26. “The central bank will play a wait-and-watch game.”
Brazil and Indonesia have even begun to raise interest rates for the first time since 2011 to tame inflation. Policy makers in Turkey, South Africa and India will join them in coming months to attract foreign investment and shore up their currencies, said Bhanu Baweja, the global head of emerging-market fixed-income and foreign-exchange at UBS AG.
“You have a potential exit of capital, and that suddenly leads to money market tightening,” said Baweja in a June 26 interview from London. “You can anchor currency expectations by increasing the costs of capital.”