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Investors brace for accelerating EM currency rally

The recent rally in emerging market currencies paused on Monday morning as the dollar regained some ground, but with recent data reinforcing views that the Fed will keep to its path of “dovish” rate hikes, analysts are predicting the EM march will restart soon.

The MSCI Emerging Markets Currency Index rose 1.24 per cent last week, its biggest weekly gain for four months, helped by weak US inflation and consumer sentiment figures, and dovish comments from Federal Reserve chair Janet Yellen, which all weighed on the dollar.

The dollar index picked up in European trading after hitting a 10-month low overnight, but that has done little to discourage EM bulls.

Rabobank’s Piotr Matys suggests central and eastern European currencies will be the biggest beneficiaries of the Fed’s slow approach to rising rates, highlighting their lower political and economic risks compared to other major EM’s such as South Africa and Russia:

The CEE currencies have significantly outperformed their high yielding EM peers so far this year.

The Polish zloty has rallied almost 14 per cent followed closely by 12.8 per cent appreciation of the Czech koruna. The South African rand has appreciated 5.8 per cent in the same period and the Russian rouble has trimmed its gains to just 3.8 per cent.

The zloty and koruna also stand to benefit from recovery among the countries’ key trading partners in the eurozone, where the European Central Bank is slowly moving toward bringing an end to its stimulus programme.

The CEE’s should continue to benefit the most from the prospects of a very gradual pace of tightening by the Fed. The CEE’s will also be supported by a strong euro, which is driven by fading political risk in the eurozone, as ongoing recovery in economic activity that will inevitably lead to the ECB gradually reducing its unprecedented stimulus

US bank Citi said it saw a return to investor inflows into EM assets last week, with the zloty among the outperformers “after a few weeks of more cautious flows”. It also noted strong demand by real money investors for Asian currencies.

Positive economic news out of Asia this morning brought further potential benefits for the wider EM space, according to MUFG currency analyst Lee Hardman.

China reported official year on year growth figures of 6.9 per cent for the second quarter, beating the government’s own targets.

Mr Hardman said “if global demand remains resilient, economic growth in China is likely to remain quite steady with only a modest moderation in the second half of the year”, a trend which “support[s] our bullish outlook for emerging market currencies”.

Second chart via Citi