NAB: The rally in emerging market currencies could come to a screaming halt

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Since the release of non-farm payrolls in the US a little over a week ago risk assets, stocks, commodities and emerging market (EM) currencies have been on a tear.

Indeed in a note to clients this morning the NAB’s co-head of global currency strategy, Ray Attrill, said of Friday’s price action:

Currencies were more lively that equities or bonds, with further strong gains for some of the most beaten up Emerging Market currencies of the past few months. The Indonesian rupiah added another 3.37% to be 9% higher on the week, and Malaysia 2.6% to be 6.9% up on the week.

But, in sobering note for anyone who thinks the turn around in EM currencies is part of an overall return to risk-seeking behaviour by investors and potentially presages further strength in developed markets, Attrill’s colleague, Christy Tan, NAB’s head of markets strategy/research in Asia, said that strength won’t last.

Tan wrote this morning:

We think that the recent turnaround in EM Asia currencies is a short term phenomenon and does not belie the start of a structural recovery. After all, Asia’s fundamental outlook has deteriorated, not improved. The latest IMF and World Bank reports are mostly highlighting downward growth revisions, as well as a cautious outlook on Asia’s ability to expand monetary and fiscal policies to shore up overall growth. In fact, we think that economies with strong linkages to commodities and China are relatively more vulnerable.

That’s important for the outlook, because as Tan highlights, concerns about conditions abroad are seen as one reason why the Fed stayed its hand in raising rates at the September, which really hammered emerging markets and their currencies. It was only the weak non-farm payrolls that stopped the rot and turned weakness into a recovery.

Here’s the chart:

The impact of the weak non-farm payrolls for Asia is that in pushing back expectations of a first Fed tightening, it gave/gives Asian central banks the room to drop rates. That’s an opportunity both the Taiwanese and Indian central banks took with a couple of surprise cuts. Singapore’s MAS will be next “cab off the rank”, Tan says.

So, with downward pressure on growth, inflation and interest rates across emerging Asia, Tan says the NAB sees “the recent USD consolidation as a brief event and expect interests to rebuild long USD/Asian FX positions to re-emerge”.

In holding that view she might just be belling the cat on the last week’s strong rally in commodities, the Aussie dollar and other risk assets as well.

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