Emerging markets hit by ‘toxic’ mix of rising rates and slower growth

Emerging market currencies have fallen by their most since the early stages of the pandemic as a “toxic” mix of rising US interest rates and slowing Chinese growth dims the outlook for developing economies around the world.

An MSCI gauge of emerging market currencies has tumbled by more than 4 per cent since early April as the Federal Reserve embarks on an aggressive tightening of monetary policy in a bid to rein in high inflation, boosting the US dollar while battering stocks and bonds. Draconian coronavirus lockdowns in China have piled on further pressure by threatening a crucial source of demand for emerging economies.

The Chinese renminbi fell to its weakest level against the dollar in more than 18 months on Monday after data showed the country’s exports grew at the slowest pace in two years last month, spurring a further bout of selling across emerging market currencies.

“We have had this cooling down of Chinese demand coming at a time when the Fed is hiking interest rates and inflation is still pushing higher,” said Cristian Maggio, head of emerging markets portfolio strategy at TD Securities. “As if that weren’t enough we still have the risks related to the war in Ukraine. It’s a very toxic combination.”

Rising US interest rates make emerging markets relatively less attractive to investors, prompting many to pull their money out of riskier economies and shift it to the relative safety of the American financial system. Even so, currencies in the emerging world had mostly shrugged off the prospect of tighter Fed policy until a month ago, helped by rate rises from emerging market central banks facing their own inflation problems last year.

Russia’s invasion of Ukraine in February, which propelled the price of goods from oil to wheat higher, also bolstered currencies of commodity-exporting countries including Brazil and South Africa.

“EM has had the tailwind of higher rates and higher commodities,” said Polina Kurdyavko, head of emerging market debt at BlueBay Asset Management. “The question was always how long that would last.”

But a more aggressive Fed, which last week increased interest rates by half a percentage point for the first time since 2000, has sparked a renewed sell-off in risky assets such as stocks while sending emerging market currencies lower.

Commodity-linked currencies including the Brazilian real and the South African rand have given up part of their earlier gains, while further pain has been heaped on commodity importers such as India, where the central bank was reported to be intervening in markets to support the level of the rupee on Monday.

“A lot of this pressure is coming from the Fed, and it isn’t really specific to EM,” said Uday Patnaik, head of emerging market debt at Legal & General Investment Management. “But right now you have a tightening of financial conditions everywhere, and EM can’t escape that.”