In early June an Assist FX note suggested EM currency stability would persist. This, in the face of increasing analyst consensus at the time pointing to the 2016/17 EM FX rally running out of steam on “crowded trade” concerns.
The primary driver for this assessment was political dysfunction in the US leading to softer US growth expectations, which would thus greatly reduce the pace of front-end interest rate hikes by the Fed. Emerging market currencies do not react favorably to a quicker pace of rate hikes in the US. Once that threat was removed, EM FX had further room to run than most analysts expected. Additionally, commodity-based currencies were benefiting from surging commodity prices in the mining sector.
Going forward, it is quite difficult to imagine a scenario where the Fed becomes more hawkish than expected as we approach yet another looming debt ceiling debacle in addition to ongoing geopolitical risk out of North Korea and elsewhere. Janet Yellen was certainly in no mood to invoke hawkish sentiment in Jackson Hole.
The wheels of global trade negotiations are not rolling as smoothly as they could be either, to put it lightly. More like threats for the wheels to come off altogether in the case of President Trump tweeting about “probably” scrapping NAFTA.
Market reactions in a risk-off environment are becoming inherently different from prior post-financial crisis years. The dollar doesn’t rally against the high yielders like it used to. In a ZIRP world the dollar is only a couple of rate hikes away from being a quasi high yielder currency itself. Now we see the ultra low yield JPY, CHF, and even EUR garnering safe haven reverse carry trade flows rather than the dollar when markets turn to risk-off dynamics. USD is acting more like an injured EM currency with political risk typically witnesses in developing countries, not a safe haven.