Sinking Real Means Emerging-Market Currency Swings Rising From 10-Year Low
Emerging-market currencies that three weeks ago showed the least volatility in a decade are dropping as traders bet slower expansion and an end to interest rate increases may weaken exchange rates from Sao Paulo to Moscow.
Implied volatility on three-month options on developing- nation currencies climbed to 13.1 percent from 8.9 percent on July 20, when it was within 30 basis points of the lowest level since March 2001 versus the Group of Seven nations, according to JPMorgan Chase & Co. All 25 emerging-market currencies tracked by Bloomberg are down this month, excluding China’s yuan and the Czech koruna, as debt crises in Europe and the U.S. and falling commodities change the outlook for economic growth, inflation and interest rates.
“The market is currently pricing in a very different growth and macro-backdrop than it expected three months ago,” said Mike Moran, a senior currency strategist at Standard Chartered Bank in New York. “This process of re-profiling the global assumptions is going to keep the pressure on emerging- market foreign exchange in particular in the near term.”
Traders are the most bearish on the Brazilian real since November after the currency posted its biggest decline in more than a year yesterday. Goldman Sachs Group Inc. cut its estimate for the Russian ruble and the Polish zloty, Westpac Banking Corp. lowered its forecast for the South African rand and Barclays Capital said it expects the Turkish lira, down 12.5 percent against the dollar in 2011, to approach a record low in a year.
Developing-nation currencies extended declines yesterday after Standard & Poor’s reduced America’s AAA rating, fueling concern the economic slowdown will worsen. Stocks sank around the world, while U.S. Treasuries rallied and gold surged to a record. Spanish and Italian bonds rose after the European Central Bank bought the debt to help stem the spread of the region’s government-debt crisis.
Emerging market currencies recouped some losses today after the Federal Reserve vowed to keep interest rates near zero through mid-2013. The Mexican peso rallied 2.3 percent 12.0391 per dollar after tumbling as much as 3.5 percent earlier. The rand gained 1.2 percent to 7.1177 per dollar, erasing an earlier loss of 5.4 percent.
Russia’s currency was the worst performer today, falling 2.5 percent against a basket of euros and dollars monitored by the central bank, according to BNP Paribas SA in an e-mailed report.
In Brazil, where the interest-rate gap compared with near- zero borrowing costs in the U.S. and Japan helped lure foreign capital and make the real the best-performing emerging-market currency since the end of 2008, traders are abandoning forecasts for more rate increases.
Yields on Brazil’s interest-rate futures indicated that policy makers will cut the benchmark interest rate from 12.5 percent by December, according to data compiled by Bloomberg. As recently as July 15, futures showed the central bank would raise borrowing costs this month.
In Russia, interest-rate forwards shows a possibility of 15 basis points, or 0.15 of a percentage point, of rate increases in the next three months, yesterday, the least since February 2010, according to data compiled by Bloomberg. Traders in India also are tearing up predictions for an interest-rate increase as soon as next month as the government says lower commodity prices may cut inflation.
The Turkish central bank unexpectedly cut its benchmark interest rate a half percentage point to a record low of 5.75 percent following an emergency meeting on Aug. 4 in a bid to “reduce the risk of a domestic recession.” The central bank also sold dollars to support the currency, the worst-performing in major emerging markets this year. The central bank has lowered its benchmark repo rate to by 125 basis points since November to 5.75 percent.
“These are still small economies, and global flows in were very big and global flows out can be very big as well,” Timothy Ash, the London-based head of emerging-market strategy at Royal Bank of Scotland Group Plc, said in a phone interview on Aug. 8.
The ruble led declines this month, depreciating 7.6 percent against the dollar to a six-month low. The South African rand weakened 5.9 percent while the Mexican peso dropped to the weakest level since September. The Turkish lira extended its losses against the dollar since November to 18.8 percent.
Slower global growth threatens expansion in developing nations. Turkey, which needs foreign investors to finance its record annual current account deficit of $68 billion, cut interest rates while inflation rose above its target to protect the economy from weakening. Russia relies on Europe to buy about half of its exports while Mexico, the second-largest economy in Latin America, depends on the U.S. to consume 80 percent of its exports as domestic demand stagnates.
“Even though emerging-market currencies have very legitimate on-going good stories behind them, almost all of them do depend on global demand and global financial flows,” Eric Fine, a portfolio manager in New York who helps Van Eck Associates Corp. oversee $3 billion in emerging-market assets, said in a telephone interview. “That may be really threatened by the growth slowdown.”
Traders expect emerging-market currencies to fluctuate an annualized 13.1 percent, according to the JPMorgan Emerging Market Volatility Index, up from 8.5 percent on July 8, which had been the lowest level since 2008. The index contains the Mexican peso, South Korean won, Brazilian real, Polish zloty, Singapore and Taiwan dollars and the South African rand.
Expected emerging-market volatility was 2.7 percentage points lower than that indicated for rich nations by JPMorgan’s G7 Volatility Index on July 20, compared with 3 percentage points in March, the biggest difference in 10 years. The difference fell to 1.1 percentage point today, when the G7 Volatility Index was at 14.
JPMorgan’s Emerging Markets Currency Index has risen 25 percent from March 2009 until yesterday, as developing countries outgrew the industrialized world and cut their debt levels.
Options show traders expect the real to fluctuate an annualized 16.1 percent over the next three months, the most since July 2010, according to data compiled by Bloomberg. It surpassed the similar gauge for the euro versus the dollar for the first time since May.
The Brazilian government has spent most of the year trying to prevent the real from appreciating, including new tax measures. While Brazil isn’t “immune” from a decline in the global economy, it has the strength to resist a slump in the U.S. and Europe, Brazilian President Dilma Rousseff told reporters yesterday.
Emerging-market countries will grow by at least 6.5 percent a year over the next six years, compared with expansions of no more than 2.5 percent for G-7 nations, International Monetary Fund forecasts show. Developing nations’ share of global gross domestic product will surpass that of the advanced economies in 2013, in purchasing power terms, according to the IMF.
The average government debt burden in China, Brazil, India and Russia, the four largest emerging economies, is 40 percent of GDP, compared with 102 percent for developed nations, according to IMF estimates.
“We need to differentiate between short-term selloff versus the medium-term trend of more diversification into a number of emerging-market assets,” said Clyde Wardle, a developing-nation currency strategist at HSBC Holdings Plc in New York. “The key point is that we don’t see a systemic spillover into emerging markets. There are good opportunities to get into some of the markets.”
Asian currencies from the Singapore dollar to the Chinese yuan will continue appreciating, according to Wardle.
The Turkish lira may decline to 1.8 per dollar in 12 months, Koon Chow, a Barclays Capital emerging markets strategist, said in e-mailed comments from London on Aug. 8. London-based Barclays revised its forecast from a previous 1.6 per dollar as the current account deficit widened to about 9 percent of the size of the economy.
The premium for the rights to sell the real versus dollar over those to buy jumped to 6 percentage points today, from 4.1 percentage points on Aug. 1, the so-called three-month risk- reversal rate showed.
Goldman Sachs turned less bullish on the ruble and zloty last week, predicting that the ruble will rise to 26.1 per dollar in a year, from 29.56 per dollar, according to a note sent to clients on Aug. 5. The New York-based bank previously forecast an advance to 25.1 per dollar. The zloty will rise to 3.96 per euro in 12 months, from 4.10, compared with the previous forecast of 3.93, according to Goldman.
Westpac of Sydney reduced its year-end forecast for the rand on Aug. 5, estimating it will strengthen to 7.24 per dollar, from 7.27, according to data compiled by Bloomberg. Australia’s second-biggest lender had expected the rand to hold at 7.2 by December.
“The biggest risk for them is the worst case scenario where the U.S. does slip into another recession,” said Standard Chartered’s Moran. If that happens, “the entire emerging-market space could start to come under even greater pressure,” he said.
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