EM FX: USD shock and rising risks – Nordea Markets

Analysts at Nordea Markets suggests that EM looks shaky as external risks are rising with the stronger USD, while domestic political risks are elevated in some countries and fundamental risks generally look less benign as per the rising EM traffic light.

Key Quotes

“Emerging Markets (EM) currencies have sold off over the last month and are down around 4% year-to-date against the USD and even more compared with the strongest levels of late January.”

“USD strengthening has been the catalyst of a much weaker general EM sentiment, while the fundamental vulnerability of a few EM currencies as well as the long list of domestic and geopolitical risks have exacerbated the sell-off and are increasingly fuelling fears of a larger EM crisis. Should the USD – or another external shock – take another go at the EM sentiment, then more vulnerability are likely to come to the fore.”

“China’s new FX policy, which manages the trade-weighted renminbi, has made it less vulnerable to loss of competitiveness, but at the risk of capital outflows. Thus, managing the trade-weighted renminbi means mitigating general USD strength by allowing the CNY to weaken against the USD. But too fast CNY weakening comes with the risk of a new round of capital outflows from locals. Moreover, the loss of competitiveness is pushed to other Asian economies with soft or hard USD pegs and China as the main export destination when USD/CNY moves higher.”