Resurgent Dollar, Higher Yields Send EM Currencies to 2024 Lows

(Bloomberg) — A gauge of developing-world currencies briefly touched a session low after Federal Reserve Chair Jerome Powell signaled interest rates will likely stay high for longer after recent inflation data.

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The Brazilian real and Mexican peso were among the biggest decliners on Tuesday, dropping at least 1.5% versus the dollar each, while the rupiah sank more than 2%, forcing Bank Indonesia to step in to support it. China’s unexpected move to weaken its daily reference rate for the yuan also added to the pressure.

The emerging-market currency index traded at the lowest level since November as the dollar hovered higher on uncertainty over the timing of interest-rate cuts in the world’s largest economy. Powell said on Tuesday that it’s appropriate to give the Fed’s restrictive policy further time to work.

Developing-nation currencies have soared for their so-called carry appeal as policymakers hiked rates earlier than their US counterpart to tame inflation. Now, with easing cycles underway from Brazil to Poland and Chile, the difference in borrowing costs will shrink and weaken developing-world exchange rates, according to Win Thin, managing director and global head of markets strategy at Brown Brothers Harriman & Co.

“It’s ‘high for longer,’” he said. “Emerging markets are front running the Fed’s cut, and that is very risky since weaker currencies will tend to boost local inflation.”

The risk off mood sent US two-year yields to 5% for the first time in five months, while the dollar extended a rally into a fifth session. Money markets are now pushing expectations of a Fed cut to November. Investors are also on edge about tensions in the Middle East after Iran’s weekend attack on Israel.

“EM currencies seem to have had an outsize move, as they often do in situations that combine risk-off sentiment and higher US yields,” said Thierry Wizman, head of global currencies and interest rates at Macquarie.

Read More: Dollar Bulldozes Its Way Through EM Currencies Aided by Yuan

Currencies from Brazil, Poland and Mexico, which have some the highest real rates in the world, have been hammered as heightened price swings derail the so-called carry trades that have made them a favorite. The Mexican peso erased its gains for the year, while Brazil’s real is trading at the weakest since March 2023 weighed down also by fiscal risks.

“Everything goes well until volatility kicks in,” said Alejandro Cuadrado, head of foreign-exchange strategy at BBVA in New York.

Traders are awaiting a string of Fed speakers in the coming days, including Cleveland President Loretta Mester and Governor Michelle Bowman.

The benchmark index for emerging-market equities lost 2%, erasing its advance for the year as China data, while better than expected, showed the economic recovery may be already fizzling out. Growth in retail sales slumped in March and industrial output fell short of forecasts. Latin American stocks traded at the lowest since November.

“A strong Chinese GDP may have not boosted appetite for Chinese stocks, but it sure boosts worries that rising Chinese growth will fuel global inflation and make major central banks think twice about their rate cutting plans,” Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, wrote in a note.

The risks for China’s economy increased further after the European Union unleashed a barrage of trade restrictions against the country. In addition to an investigation into Chinese subsidies for electric vehicles, the bloc is looking into whether Beijing provided illegal support for wind parks on the continent. It has also brought subsidy probes into solar and railway firms and will shortly launch an inquiry into China’s procurement of medical devices.

Risky Debt

Elsewhere, the yuan fell to the lowest level since November and sparked a selloff across Asia after the People’s Bank of China unexpectedly set a weaker daily reference rate for the managed currency. The Indonesian rupiah was the worst performer among developing peers despite central bank intervention. Poland’s zloty sank to the lowest level this year against the dollar.

The Israeli shekel slid on Tuesday rattled by geopolitical tensions as top military officials said Israel has no choice but to respond to Iran’s weekend attack.

Sri Lanka, meantime, led losses in the dollar bond market as its first round of restructuring talks with investors failed. Investors also dumped notes of Pakistan, Angola, Nigeria and Egypt — countries that have rallied in recent months amid a craze for risky debt, just as emerging market investors, policymakers and International Monetary Fund officials convene in Washington D.C. this week.

–With assistance from Selcuk Gokoluk and Carolina Wilson.

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