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Interpreting Recent Emerging Market Currency Movements

From Econbrowser by Menzie Chinn:

Expectations of central bank policies are only part of the story

The rapid decline in emerging market currency values has been quite remarkable:

 

emcurrencies

Figure 1: Log exchange rates against USD for India (dark blue), South Africa (red), Turkey (green), Brazil (teal), Thailand (chartreuse), and Argentina (purple), all normalized to 2013M05=0. January data is for 1/22. Source: St. Louis Fed FRED, Pacific Exchange Services, and Financial Times.

The movements at first glance would seem to be attributable to revisions to expectations regarding future central bank policies — both quantitative/credit easing as well as the path of short rates (discussed in this post, as well as this June post). As Steven Englander (Citi) noted on Friday:

  • The sell-off in high-beta currencies, particularly in EM, is driven by an abrupt change of tone among G10 central banks with respect to liquidity provision. The fear is that the Fed, BoE, and even the BoJ will become less dovish more quickly than had been though even a few weeks ago. The question is whether one or more of these CBs will act to reverse this view, given that central banks talk all day about cooperation, but act only when disruptions abroad threaten national economies.
  • The Fed and the BoJ look most likely to signal that market fears of an abrupt pullback from abundant liquidity provision are overdone. Recent BoJ comments are stoking the fire, but there is unwelcome collateral damage to USDJPY and the Nikkei. The Fed is likely to be obsessed next week with domestic policy considerations rather than global repercussions. Most likely outcome is that we see more market friendly comments, but no indication of substantive change in policy.

But as Englander observes, G-3 central bank policies are not the only drivers; other global factors as well as domestic political factors are also weighing down on some currencies. This proposition is expanded upon in posts by Kaminsky at FT and Fernholz at Quartz.

 

The Other Factors

The global factor is China, or namely the Chinese slowdown [1] which presages (perhaps) lower commodity prices [2]. Domestic political factors are prominent in Argentina and Turkey.

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