Why emerging market currencies won’t rally against the dollar near term

World currencies

The rally in emerging market currencies appears to be over and it’s not set to resume any time soon, Capital Economics said.

Emerging market currencies’ performance has been mediocre, coinciding with a general pullback in risky assets, Capital Economics said in a note dated Friday, adding that protectionism fears haven’t helped.

“While EM currencies have not fared as badly as they did after President Trump’s election – and the Mexican peso has actually strengthened as the chances of a NAFTA deal have improved – the U.S.-China trade spat has taken a toll,” it said. “Even if protectionism worries blow over, we still expect global equities to fall a lot further in the next couple of years as the U.S. economy begins to falter.”

Capital Economics also expects growth in emerging-market economies will slow, particularly in China, which will likely weigh the yuan against the dollar.

“Slower growth in China would probably also have a knock-on effect on commodity prices, which we generally expect to weaken,” the note said. “This would be likely to weigh on the EM currencies which typically track them. For example, we suspect that the recent boost to the
Colombian peso from higher oil prices will unwind.”

But while Capital Economics doesn’t expect emerging market currencies to rally against the dollar anytime soon, it also didn’t expect large declines, at least by past standards.

It noted that most emerging markets, except for Turkey, have healthy current account balances, while real effective exchange rates don’t appear particularly strong, which should help limit any losses.