According to a recent poll, emerging market currencies that have already taken a beating this year will continue to struggle when it comes to holding the gains they have made recently by the year end. This is because the US dollar is likely to remain at the forefront because of the concerns about inflation and the continued rate hike by the US Federal Reserve. Emerging market currencies had not yet made a full recovery from their bear-run that had lasted for nearly two years when positive sentiment once again suffered due to the increase in US Treasury yields.
The emerging markets currency index had reached its lowest level last month, which was last seen at the end of 2020 and this occurred due to greater inflows in the safe-haven US dollar. However, there was a recovery after bets of aggressive increase in interest rates by the Fed were scaled back a bit and this drove down the greenback. But now, most of the currency analysts believe that the weakness of the dollar will not last for long and they expect it to advance further against currencies of emerging markets in the next few months.
Market strategists said that emerging market currencies had had a difficult year so far because of the slowdown in China, the conflict between Russia and Ukraine, the hawkish stance of the US central bank and a debt sell-off in Russia. 2021 had also been a painful year for emerging markets and analysts had hoped that 2022 would turn out differently, but the reality had turned out to be completely opposite. Nearly all of the crises that had occurred previously in emerging markets had been due to the strengthening of the greenback. When the dollar goes up, there is no other option for developing countries other than tightening their own monetary policy, or else their own currencies go down.
If they do not make this move, it only results in inflation and this means a higher cost of debt dominated in the US dollar. Market strategists said that until the inflation trend moves downward in the US, it is highly unlikely that emerging markets will see any change in their story. While values have indeed gone down and positions are clear, but this is not enough to give a boost to investor sentiment. Wednesday saw the dollar index gain again, as there was a rise in Treasury yields and risk appetite remained subdued because of the possibility of higher inflation globally.
In the short-run, experts believe that it is likely that the markets will remain uncertain because the growth outlook is choppy all over the world and inflation continues to remain high. Hence, emerging market currencies will not have a lot of room to move past their recent ranges. The behavior of the Chinese yuan will play a great role in determining the direction of EM currencies. But, most of them are expected to remain weak for now, such as the Turkish Lira that has already lost 20% this year.