Emerging FX Markets: How Bad Can It Get?‏

Emerging markets have been hammered this week. Most of the high-yielding currencies have been under strong selling-off pressure as investors have been reducing risk in an attempt to get rid of high-yielding emerging market assets amid concerns of an early Fed exit and a Chinese recovery. The significant move in emerging market assets was also enhanced by the month end. The hardest emerging market FX were the currencies with the biggest external imbalances such as the South African rand and Turkish lira. The rest of the emerging market currencies were not saved from the sell-off, when suddenly everyone wanted out of emerging markets.

Can this sell-off go further or is this a buying opportunity?
As mentioned above, the biggest risk in sentiment towards emerging markets is for those currencies with the large external imbalances. The South African rand and Turkish lira come particularly to mind, with neither country having a sustainable current account deficit. Furthermore, the biggest risk of even further sell-off is for the South African rand, where, besides the large current deficit, labour market unrest and ongoing strikes in the mining industry further undermine investors’ confidence in South Africa.

The question is now if the sell-off will continue or will some stabilization become evident. It depends much on global sentiment and Fed QE exit plans, but mostly on Chinese growth prospects. At this point we would not say that the sell-off is about to end, and we will get happy days again next week. We do not believe that this is a buying opportunity, and we recommend staying cautiously in emerging markets at this time. We could see the sell-off continuing in the ZAR and the TRY in particular. However, our EMEA Scorecard also indicates that the Polish zloty could continue depreciating, as aggressive monetary policy easing is likely to put further pressure on the currencyin coming months.

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