EM Currencies to Remain Susceptible in the Run Up to the Fed

EM Currencies to Remain Susceptible in the Run Up to the Fed

30 May 2016, 18:02
Roberto Jacobs

EM Currencies to Remain Susceptible in the Run Up to the Fed

Fed Chairwoman Janet Yellen in a speech at a panel discussion at Harvard University on Friday said that the central bank would “probably” raise interest rates in the coming months if the U.S. economy keeps gaining strength. Hawkish Yellen’s comments have raised the odds of a rate hike in June-July.

However, the Fed fund futures market still underestimates the likelihood of a Fed rate hike in June-July and hasn't fully discounted a 25 bp hike over the remainder of this year. As US dollar extends strength, EM Asian currencies are expected to remain susceptible to resurfacing concerns over the Fed’s tightening and to weaken against the dollar in the coming weeks. CFTC positioning data has also shown that aggregate dollar position jumped USD 8.1bn to net long territory in the week ended 24 May from a week earlier.

The MYR and the KRW were the most vulnerable currencies in May, followed by the IDR, the SGD and the THB. The PHP gained about 0.55% month-to-date given the removal of political uncertainty post the Presidential Election held on 9 May. The CNY, the CNH and the INR were relatively steady on account of the two central banks’ commitment to curb extreme movements in local FX markets.

"We think a Fed rate hike in July is more likely by considering Brexit Referendum scheduled for 23 June and Spanish General Election due on 26 June, followed by another interest rate increase at December FOMC meeting." said Scotiabank in a report.

That said, Fed will not risk tightening too much and too quickly. Yellen said on Friday that “if we were to raise interest rates too steeply and we were to trigger a downturn, we have limited scope for responding and this is an important reason for caution.” Hence, EM Asian currencies will recoup their losses after July FOMC meeting if a rate hike is delivered as expected.

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