Emerging market central banks, from Brazil to South Korea, are actively intervening to defend their currencies against a strengthening US dollar that has pushed them to multi-year lows.
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Emerging market currencies react to dollar strength
Bangko Sentral ng Pilipinas is closely monitoring the peso’s decline and has increased its intervention in the currency market, according to Governor Eli Remolona. Brazil’s central bank has spent a substantial $17 billion in the past week to bolster the real. Bank Indonesia has committed to “boldly” defend the rupiah to restore market confidence. Even in Europe, Hungary’s central bank raised the interest rate on its foreign-currency swap tender in an effort to stabilize markets.
Dollar Strength Fuels Defensive Measures
These actions come as the dollar’s persistent strength creates turmoil in global markets. The South Korean won has plummeted to a 15-year low, while the Indian rupee and the Brazilian real have crashed to record lows. Such rapid currency depreciation threatens to exacerbate the impact of imported inflation in emerging markets and could increase the cost of servicing foreign debt.
“Countering a strong USD trend is challenging,” notes Christopher Wong, a currency strategist at Oversea-Chinese Banking Corp. in Singapore. “Intervention can only temporarily slow the pace of depreciation. Central banks will likely need a combination of verbal and actual intervention tools.”
Emerging Market Currency Index Plummets
The MSCI Emerging Markets Currency Index has dropped 3.2% since the end of September, on track for its worst quarterly performance in two years. The real, the Hungarian forint, and the Chilean peso are leading the decline. This follows the Federal Reserve’s projection of fewer interest rate cuts next year and renewed concerns about inflation.
MSCI Emerging Markets Currency Index performance
Anticipating continued dollar strength, policymakers in developing economies are implementing various measures. South Korea announced a 50% easing of the cap on banks’ foreign-exchange forward positions to encourage inflows and address currency imbalances. China’s central bank continues to prop up the yuan by setting its daily reference rate stronger than market expectations.
Domestic Factors Compound Currency Woes
However, the dollar’s strength isn’t the sole factor driving these declines. The real has been further weakened by concerns over Brazil’s deficit after President Luiz Inacio Lula da Silva diluted a fiscal austerity plan with tax relief measures. Geopolitical risks and domestic economic headwinds have contributed to the Hungarian forint’s recent weakness.
Short Bets Against Emerging Markets Rise
The downturn in emerging markets has spurred a wave of bearish bets, with some hedge funds anticipating further losses as potential trade policies unfold. Bradley Wickens, CEO of Broad Reach Investment Management LLP, confirmed short positions on the Mexican peso and currencies in North Asia, the Middle East, and Eastern Europe. Even developed nations, such as Japan, are experiencing pressure, with officials issuing warnings against currency speculation and hinting at potential interventions.
Intervention Costs and Volatility Concerns
These efforts to combat a stronger dollar come at a cost, depleting foreign-exchange reserves. “The dollar’s ascent is fueled by the Fed’s less dovish stance, but reduced liquidity in December can amplify market moves,” observes Alan Lau, an FX strategist at Malayan Banking Berhad in Singapore. He anticipates central banks will continue to mitigate volatility and prevent drastic currency fluctuations. Ultimately, emerging markets face a difficult balancing act as they navigate the challenges posed by a resurgent dollar.
