Emerging market currencies are suffering their worst start to the year since 2020

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Emerging market currencies are on track for their worst first half of the year since 2020, pushed lower by an unexpectedly strong dollar and a relaxation in a popular trading strategy in Latin American markets .

JPMorgan’s emerging market foreign exchange index has fallen 4.4 percent so far this year, more than double the decline over the same period in the previous three years. The move came as investors dashed hopes of a quick US interest rate cut in 2024 and nerves about weakening economies and expansionary fiscal policies pushed currencies lower in several key emerging markets.

“It’s the combination of a more resilient economy in the US and, on the emerging markets side, emerging markets like Chile, Hungary and Brazil have continued to cut rates,” said Luis Costa, global head of emerging markets strategy at Citigroup.

“And let’s be honest, the outlook for growth in EM is not amazing for this year and next year – there’s an ongoing contraction in global trade and it’s a very tricky election year,” he added.

Much of the recent weakness has come from the unwinding of so-called “carry trades,” where investors profit from differences in yields between currencies. The trade was popular with emerging market investors earlier this year.

But in larger emerging markets in particular, these trades have run into trouble as the election made assets more volatile and the future path of local interest rates also became less clear.

The Mexican peso’s recent weakness has been “an example of the softening of a significant forex trade that was previously building for two years, from mid-2022 to the end of May 2024,” JPMorgan analysts said this week.

The Mexican peso has fallen by almost ten percent since the country’s ruling party Morena won a landslide victory that raised concerns about fiscal policy in Mexico and increased intervention in the economy. Investors say the effects spilled over to other Latin American currencies such as the Colombian peso and the Brazilian real.

“The latAM forex has been mostly responsible for the recent weakness – it was driven by some of the political changes, but there was a very heavy positioning in some of the higher currencies and that caused all trade to soften,” Grant said. Webster, a portfolio manager at fund firm Ninety One.

Some investors have shifted carry trades from larger markets such as Brazil to smaller, poorer economies that are emerging from periods of turmoil and where they believe policies that include high interest rates still make bond bets attractive. in local currency, for example Nigeria and Egypt.

Asian currencies, among the hardest hit by a weak Chinese economy, have also suffered this year. South Korea’s won has fallen 7 percent against the dollar, while the Thai baht and Indonesian rupiah have each fallen about 6.5 percent.

Currencies around the world have struggled this year to perform against the dollar, which has risen 4.5 percent against a basket of six major currencies as strong U.S. economic data and steady inflation forced a major revision to the outlook. for interest rates.

Investors are now betting on two rate cuts by the Federal Reserve this year, up from six or seven at the start of the year.

“Somewhat more than half of the EM weakness has been around dollar strength,” said Kieran Curtis, emerging markets portfolio manager at Abrdn. “At the beginning of the year investors thought it could be six or seven [US] rate cuts this year – and now there can be none.”