EM prices could suffer in September – Swissquote

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The converging policy paths of the US Federal Reserve and the European Central Bank could have a profound impact on the pricing of emerging markets (EM) currencies if expectations of a tapering move from the ECB in September prove correct, says Peter Rosenstreich, head of market strategy at Swissquote Bank.

For EM currencies, there is a lot at stake. After nearly a decade of extraordinary easing, the ECB could embark on tapering its bond-buying programme later this year.

“The recent shift in a few G10 central banks’ tones toward normalisation, a rapid rise in yields and weakness in EM currencies indicates there is significant risk in unwinding extraordinary loose policy. In September, we expect Fed and ECB policy will converge, with both taking real policy steps towards tightening, which could have a profound effect on EM prices,” says Rosenstreich.

Swissquote topped FX Week’s one-month currency forecast tables.

The convergence between policy paths will be even more amplified as the pace of tightening in the US slows. Since the euphoria and expectations for growth surrounding President Donald Trump’s proposed fiscal stimulus package, hopes have faded that these policies will translate into reality, leading to market participants scaling back the path of rate hikes in the US.

For now, US data points show a moderate, but healthy expansion, with the economy notching up 2.6% growth in the second quarter of this year. But while strong US data and expectations of more tightening from the Fed tend to take the wind out of the sails of EM currencies, the situation could be set for change as the market re-evaluates the US central bank’s likely path.

Trump has failed as a political deal-maker, so anti-China trade rhetoric feels empty while China economic data continues to improve

Peter Rosenstreich, Swissquote Bank

“Developed-market central banks’ normalisation remains a massive risk in our view,” says Rosenstreich. “Weak US economic data and decreased expectations for Fed tightening supports EM risk-taking. In the medium term, we expect EM currencies to appreciate against the dollar, and while we are concerned about the next few months, markets should be able to handle the slow removal of extra loose policy in the medium and longer term.”

Rosenstreich cautions that in the short run, moves could become volatile and sharp, as carry trade positioning is becoming increasingly stretched. “The closer we move towards September, the more cautious traders will get,” he notes.

Meanwhile, the rollback of hopes pinned on Trump’s policy package will benefit China, he says. “Trump has failed as a political deal-maker, so anti-China trade rhetoric feels empty while China economic data continues to improve. We have thought for a while now that China will be the biggest beneficiary of a Trump administration, because greater instability in US policy could lead to Asian nations joining together, with China becoming the regional leader.”