Emerging market currencies under pressure

One of the key factors that have provoked the current bout higher risk aversion was the sub-50 Chinese manufacturing confidence gauge (PMI) which has intensified concerns about slowing growth . Additionally reports regulators in China have issued warnings about credit to the coal industry has reinforced debt fears in the country.

Domestic fundamental and political pressures in other currencies have contributed to the malaise in emerging markets, with a major drop in the Argentine peso and pressure on many other high beta emerging market currencies (including the usual suspects Turkish lira, South African rand and Indian rupee).

A deteriorating outlook for many emerging markets currencies based on concerns about the impact of Fed tapering and slowing emerging markets growth appears to be increasingly intensifying. Competition for capital as the Fed tapers will make things worse. The pressure is unlikely to ease quickly leaving many EM currencies vulnerable to a further sell off.

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JPY and EUR find support

Rising risk aversion is supporting the JPY but the currency may also be finding some support from the misplaced view that the Bank of Japan may not need to be any more aggressive in its policy stance to reach its 2% inflation target, with Japan’s finance minister noting that deflationary conditions have almost ended. Such talk looks premature.

Japan still has a long way to go to reach and sustain inflation at its target. The risk is that without any structural reforms (jobs market, manufacturing sector, immigration) deflation and slower growth could quite easily take hold again. In any case, the Bank of Japan is likely to embark on more aggressive policy in the months ahead in order to achieve the 2% target. In the near term USD/JPY looks supported around 102.50.

The EUR found some additional support from a strengthening in manufacturing confidence in the region, which highlighted that economic recovery continues to take shape. Fitch’s affirmation of Germany’s credit ratings at AAA has also helped sentiment towards the currency.

In the near term much of the same tone is likely although the relatively stronger US economic performance and tapering expectations will mean the USD will not fall too far. EUR/USD will face technical resistance around its 2014 high at 1.3776.

Lower US yields undermine the US dollar

A drop in US yields has undermined the USD over recent days against major currencies although emerging market currencies remain under varying degrees of pressure. US 10 year Treasury yields have fallen by around a quarter of a percent since the end of last year, acting as a real drag on the USD.

A rise in risk aversion over recent days (the VIX fear gauge has risen by over 13% since its low on 10 January) appears to have resulted in increased demand for Treasuries and weaker equities, with markets ignoring generally firmer than anticipated US economic data this week including weekly jobless claims and existing home sales.

Emerging market currencies have come under strong pressure while the usual safe havens have strengthened most against the USD in particular CHF and JPY. The EUR has also made up some ground. Fortunately for the USD expectations of Fed tapering continue to fuel some buying of the currency, constraining any downside. Nonetheless, until US Treasury yields resume their upward movement the USD’s upside momentum will be limited.

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