EM currencies to resume their rise against the US dollar this year – CE

Emerging market currencies have generally had a slow start to 2021 after appreciating significantly against the US dollar in the second half of 2020, with most little changed or a bit weaker against the dollar. Nonetheless, economists at Capital Economics think emerging market currencies will resume appreciating against the US dollar before long, even if yields of US government bonds continue to rise a bit.

Key quotes

“We doubt that interest rate differentials between EMs and the US will widen by much. For one, we think US yields would only rise a little, if at all. What’s more, because EM central banks are generally exerting less downward pressure on government bond yields than their DM counterparts, a rise in US yields could well lead to higher EM yields too. This means the interest rate differentials would not change much, limiting any downward pressure on EM currencies.”

“We suspect investor appetite for risk is likely to remain strong, amid the backdrop of a rapid economic recovery and supportive monetary and fiscal policy. This is particularly important for EM currencies, since EM assets are generally seen as riskier investments than their developed market equivalents.”

“Even in a generally supportive environment for EM currencies, country-specific risks will probably weigh on some currencies. We expect this to continue to some extent: in Brazil, for example, we think the government will break its fiscal spending cap, which would dent investor confidence and see the real depreciate further.”