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Emerging market currencies are on track for their worst first half of the year since 2020, pushed lower by an unexpectedly strong dollar and a decline in a popular trading strategy in Latin American markets.
JPMorgan’s emerging markets currency index is down 4.4 percent so far this year, a decline more than double the same period in the previous three years. The move comes as investors have given up hope of rapid US rate cuts in 2024 and nerves around weakening economies and expansionary fiscal policies have pushed currencies down in some major emerging markets.
“It’s the combination of a more resilient economy in the US and, on the emerging markets side, emerging markets like Chile, Hungary and Brazil have continued to cut rates,” said Luis Costa, global head of emerging markets strategy at Citigroup.
“And let’s be honest: the growth prospects in emerging markets are not great for this year and beyond. There is a continued contraction in global trade and it is a very complicated year for elections,” he added.
Much of the recent weakness has stemmed from the disappearance of so-called carry trades, where investors take advantage of differences in returns between currencies. The deal was popular with investors in emerging markets earlier this year.
But especially in the larger emerging markets, these trades have run into trouble as the election has made assets more volatile and the future path of local interest rates also less clear.
The Mexican peso’s recent weakness is “an example of the unwinding of a large currency trade that previously built up over 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 Morena party won a landslide victory, fueling concerns about Mexico’s fiscal policy and increasing interference in the economy. Investors say the effects spread across other Latin American currencies, such as the Colombian peso and the Brazilian real.
“The Latin American currency has been largely responsible for the recent weakness – it was caused by some political changes, but there was some very heavy positioning in some of the higher carry currencies and it caused the whole trade to settle down” , Grant said. Webster, portfolio manager at fund firm Ninety One.
Some investors have shifted their carry trades from larger markets such as Brazil to smaller, poorer economies that are emerging from periods of turmoil and where they believe that high interest rate policies still make bets on local currency bonds attractive, for example Nigeria and Egypt.
Asian currencies, which have been hardest hit by China’s weak economy, have also struggled this year. The South Korean won has fallen 7 percent against the dollar, while the Thai baht and Indonesian rupiah have each fallen about 6.5 percent.
Currencies around the world have struggled to perform this year against the dollar, which has risen 4.5 percent against a basket of six major currencies, after strong U.S. economic data and stubborn inflation prompted a major rethink. interest rate forecasts.
Investors are now betting on two Federal Reserve rate cuts this year, down from six or seven at the start of the year.
“Just over half of emerging market weakness has to do with dollar strength,” said Kieran Curtis, emerging markets portfolio manager at Abrdn. “At the beginning of the year, investors thought it could be six or seven [US] interest rate cuts this year – and now that can’t happen anymore.”