FXStreet (Delhi) – Research Team at Danske Bank, notes that after more than two year’s anxious wait, the Fed delivered its first rate hike and the big uncertainties are whether the Fed move means that emerging market currencies are finally out of the woods and whether we could see a stronger path in the new year.
Key Quotes
“Our immediate answer is maybe but go very selectively and be prepared for significant bumps along the way. There is no doubt that the first Fed hike has removed some of the uncertainty, which has left policymakers and investors in emerging markets struggling.
We need to keep in mind a point that Janet Yellen reminded us of at her press conference, i.e. that emerging markets usually benefit from strong US growth, which is the background for the higher interest in the US. Another point to keep in mind, which we have highlighted over the past couple of months, is that, unlike in other Fed tightening cycles, this time many emerging markets have more flexible exchange rate systems. This mean their exchange rates have taken the brunt of the adjustment over the past two years, helping to close large external imbalances and eventually overcome the shock faster than holding onto an overvalued peg.”
“However, an issue that we need to keep in mind is the large dollar debt accumulated mainly by emerging market corporates. These have much higher debt service costs, which deters investment and is a drag on growth in some of the most exposed countries.”
“In our view, the market is interpreting the Fed too softly. If the Fed moves more aggressively than expected by the market, we might well see further emerging market currency pressures. However, for many emerging markets a backlash of weaker currencies would be higher debt service costs, which would hurt.”
“Hence, our best recommendation for 2016 at this stage is to treat emerging markets highly selectively. We recommend looking for energy-importing emerging markets with large export shares to the US and which have seen a large FX adjustment, such as Asian, some Latin American and Eastern European countries. India is certainly a country that meets the criteria but Mexico and Turkey also look promising. Although we believe commodity producing countries will be under a lot of pressure, we may see a turning point in some of the countries that have allowed large upfront exchange rate adjustments, such as Russia.”
(Market News Provided by FXstreet)