Emerging currencies sold off further on Tuesday with Turkey’s lira and South Africa’s rand hitting multi-year lows against a stronger dollar as expectations of a U.S. interest rate hike compound domestic fiscal and political woes.
Buoyed by sturdy US economic growth and a gradual end to the Federal Reserve’s easy monetary policy since mid-2014, the dollar index has risen to its highest in almost 11 years.
Many developing markets have meanwhile seen investors grow increasingly cautious as wilting economic prospects have prompted central banks to cut interest rates.
“We are seeing the largest weaknesses in some of the familiar emerging markets like South Africa, Turkey and Brazil,” said William Jackson, senior emerging markets economist at Capital Economics. “Politics seems to be playing a role.”
Protracted periods of dollar strength have been rare during the 40 year-era of floating exchange rates, but have tended to trigger problems in emerging markets when they have happened. Most notably, in 1997/98, many Asian countries and Russia were forced to dramatically devalue their currencies, with some defaulting on debt.
Because emerging market governments and companies rely disproportionately on dollar borrowing, greenback appreciation makes repaying their loans more expensive, sometimes sowing seeds of default and contagion.
Brazil to Turkey
On Tuesday, the Brazilian real dropped to its weakest level in over a decade, while South Africa’s rand plunged to a 13-year low against the dollar and Turkey’s lira traded within sight of a record low it hit last Friday.
Investors in Brazil are fretting over a corruption scandal at state-controlled oil company Petrobras and the government’s ability to consolidate public finances. In South Africa, chronic electricity shortages, labour unrest and a gaping current account deficit have cast a cloud.
Doubts meanwhile prevail over the independence of Turkey’s central bank, which has come under intense pressure from President Tayyip Erdogan to cut rates. According to sources, Prime Minister Ahmet Davutoglu will meet Central Bank Governor Erdem Basci and nine cabinet ministers on Tuesday to discuss the lira’s recent fall.
And there could be more weakness ahead, said Jackson.
“If you’re looking at the risk of a crisis, the key thing to look at is what kind of vulnerabilities exist in these economies and how exposed they are particularly to dollar debt,” he added.
Currencies in Asia followed the pattern, with South Korea’s won skidding to fresh 1-1/2 year lows as offshore funds sold their positions while the Singapore dollar and Malaysian ringgit hit multi-year troughs.
Eastern European currencies were weaker against euro across the board.
Both Romania and Hungary reported inflation data on Tuesday that was higher than expected, though overall levels were still well below target.
The currency weakness spread to other assets, with emerging market stocks trading 1.3% lower, chalking up losses for the eighth consecutive session.
Russian dollar-denominated stocks fell more than 3% on the day, while their rouble denominated peers gave away more than 2%, also hit by oil slipping below $58 per barrel.