The prospects for emerging-market currencies against the US dollar look more formidable than the outlook for major peers. That’s because interest-rate differentials and nuances between central banks will likely matter more for developed market currencies than developing-nation peers.
The Federal Reserve’s pushback against aggressive rate bets is sending the greenback higher on Thursday as traders digest the Fed’s hawkish cut. The commencement of its cutting cycle eases constraints on emerging markets from higher US rates. This is happening against a backdrop of an environment where the US economy is holding up. Higher yielding EM currencies and other higher beta currencies will likely benefit from looser financial conditions and robust global growth. The trajectory against the likes of the euro seems less clear. The dynamics between the two major central banks will matter more. The Fed has mentioned that easing will take on a more measured approach in line with its counterpart, putting rate differentials in check. Swap spreads which arguably overextended in the run up to this week’s FOMC meeting may have to adjust in line with broader expectations, providing some support for the US dollar. As long as US rates stay elevated, EUR/USD’s upward path will be thwarted. Central banks more aggressive than the Fed will struggle, which will put the Canadian dollar and the Swedish Krona, for example, under more pressure. Bloomberg Markets Live team Executive Editor Mark Cudmore argues: the dollar will remain “in a volatile downtrend overall, undermined by the Fed’s dovish reaction function, the hit to policy credibility and upcoming political noise, but intermittently supported by a steeper yield curve and bouts of risk-aversion.” I do have sympathy with his view, but not necessarily the conviction. If rate differentials continue to favor the US dollar, then the greenback will remain supported against its G-10 counterparts. Mary Nicola is a macro strategist for Bloomberg’s Markets Live team, based in Singapore. |