After a white-knuckle rollercoaster ride of a first quarter, volatility has stabilized as emerging market currencies generally rallied in the second quarter. As we see it, EM currencies overcame three major hurdles in the Q2:
1) A Busy Election Season
As we noted in our Q2 report, there was an unusual confluence of major elections in Emerging Markets last quarter. On the whole, these elections went smoothly with no major surprises to spook traders. The increase in political certainty could provide a tailwind for EM currencies heading into the latter half of the year.
2) Ongoing Fed Taper
The Federal Reserve stuck to its guns in Q2, continuing the gradual wind-down of its Quantitative Easing program amidst generally improving economic data. The likely completion of the Fed’s taper by the end of the year raises concerns for EM currencies, which have been a major benefactor of the global liquidity glut. However, as of writing in mid-June, the ECB has stepped up by introducing a bevy of measures meant to stimulate the moribund Eurozone economy, and the US has pledged to keep monetary policy low even after the end of tapering. Hence, EM currencies may be generally supported in Q3.
3) Escalating Violence Between Ukraine and Russia
Though the global news media toned down its coverage of the ongoing clash in Ukraine last quarter, the situation remains a major risk heading into this quarter. Russian President Vladimir Putin has pulled back the troops from the Ukrainian border so the risk of a wide international conflict has receded, but the internal strife remains heading into this quarter. Pro-Russian separatists continue to lay siege to cities in Eastern Ukraine, while newly elected Ukrainian President Petro Poroshenko calls the insurgency a “war.”
This situation has been simmering for five months already without boiling over, but further escalation of the violence in Ukraine could boost volatility in EM this quarter. Readers are encouraged to keep an eye on the USDRUB currency pair as a proxy for geopolitical risk in the region; if USDRUB starts to perk up toward the all-time high at 36.90, other EM currencies could also come under pressure in Q3.
Below we discuss a number of emerging countries (and their currencies) individually, but readers would be wise to note that emerging markets can be interrelated and the market’s attitude about one country can spread to other countries at a moment’s notice.
The US dollar fell against the Mexican peso in the early second quarter as traders became more convinced that the Banco de Mexico would hike interest rates in early 2015 before its Northern counterpart, the Federal Reserve. However, in early June, the Banxico shocked everyone with a surprise 50bp interest rate cut down to 3.0%. In its decision, the bank cited a widening output gap and disappointing growth in GDP. However, the statement did indicate that additional cuts were unlikely, leading many to view this decision as a one-off.
From an economic perspective, export growth and rising public spending supported the economy in Q2, and continued strength in exports is favored in Q3. As always, the Mexican economy remains heavily dependent on growth in the US, its most important trading partner.
From a technical view, June’s surprise cut caused the USD/MXN to break out of its 5-month downtrend, but the 50-day and 200-day moving averages are still pointing lower as we go to press. For this quarter, the previous lows from 2013 at 12.83 (December) and 12.75 (October) may provide near-term floors for the pair, and only a recovery back above the 200-day MA and the 38.2% Fibonacci retracement at 13.12 would shift the longer-term bias back to the topside.
Figure 11: USD/MXN Daily
As we noted in the introduction to this section, the USDRUB continues to be driven by geopolitical developments in Ukraine rather than Russia’s economic prospects. That said, the Russian officials have publicly pivoted away from their focus on Ukraine in recent weeks, and if the regional tensions die down this quarter, the focus may turn back to traditional drivers like economic growth and inflation.
According to recent data, the Russian economy likely experienced an outright contraction in the first half of the year, and with inflation still elevated, the Central Bank of Russia (CBR) may not be able to deliver any stimulus until Q4. Traders will keep a close eye on inflation data this quarter to see whether it recedes from its recent level above 7% back toward the central bank’s target range of 3.5-6.5%.
On a technical basis, the USDRUB has fallen from its March peak and is currently trading between its 50- and 200-day moving averages. Moving forward, support may emerge at the confluence of the 200-day MA and the 61.8% Fibonacci retracement in the lower-34.00s, but if that floor is broken, more weakness toward 33.00 or lower is possible.
Figure 12: USD/RUB Daily
The Singapore dollar was generally rangebound against the US dollar in Q2 as the Monetary Authority of Singapore (MAS) maintained a generally tight stance toward the currency. Heading into Q3, Singapore’s economic outlook is relatively bleak, as delayed government investment and weak semiconductor output (a major export) are expected to keep a lid on economic growth. From a charting perspective, the pair is trading in a tight range between 1.2440 and 1.2590; a break of either of these levels this quarter could foreshadow the next swing, with a bearish breakdown exposing the one-year low at 1.2340 and a bullish breakout opening the door for a possible run toward 1.27 or 1.28. Given the downward sloping 50- and 200-day MAs, while the technical signals suggest that there could be further downside in this pair, conservative readers are encouraged to wait for a confirmed breakout before trading.
Figure 13: USD/SGD Daily
The USD/ZAR was one of the most interesting EM currency pairs last quarter. In early May, South Africans took to the polls to vote in the country’s fifth free election and easily re-elected the ruling African National Congress (ANC). The new generation of ANC politicians is stepping into a difficult economic situation: ongoing strikes in the country’s critical mining sector actually caused GDP to contract by 0.6% in the first quarter, though there is talk of a potential end to the strikes as we go press. Even if the strikes are resolved quickly, it will still take weeks, if not months, for the mines to build back up to full capacity.
From a technical perspective, the USD/ZAR put in a small double-bottom at 10.28 in May, and rates are rallying back toward the 11.00 handle as of writing in mid-June. The secondary indicators are also constructive, with the MACD trending higher above its signal line and the “0” level and the RSI back in bull territory. For this quarter, there is the potential for a move up to previous resistance levels at 10.95 or 11.40, though a resolution of the mining strike may take the pair back down to moving average support around 10.45 or the previous lows at 10.28.
Figure 14: USD/ZAR Daily
The last major bit of political risk comes from Turkey, which holds Presidential elections on August 10 with a potential runoff on August 24 if no candidate achieves a majority. In general, the position of president is largely ceremonial in Turkey, but current Prime Minister and political heavyweight Recep Erdogan has already hinted that he would increase presidential powers if he decides to run. Once the election is complete, the new leadership will have to combat a rising current account deficit that prompted ratings agency Moody’s to downgrade Turkey in early April. While the overall economy is growing decently, the elevated inflation rate (near 10%) is a legitimate concern as well, though most economists expect it to recede this quarter.
On a technical basis the USDTRY has been rangebound between 2.0700 and 2.1550 for the past few months, but there could be a break out this quarter. The imminent bearish cross of the 50- and 200-day MAs would create a “death cross” in the pair, and the RSI remains mired in bear territory as we go to press. A bearish break may open the door for a continuation down to key psychological support at 2.00 later this quarter, whereas a bullish rally through 2.1550 could open the door for a run back toward the mid-2.20s over the course of the summer.
Figure 15: USD/TRY Daily
As you can see, each emerging market currency has its own unique challenges and opportunities this quarter. As long as no major shocks hit the world economy in the second quarter, the market should continue to discriminate between stronger and weaker emerging markets, rather than treating all emerging market currencies as one asset class.