US Dollar Strength Puts Pressure On Emerging Market Currencies

Emerging market currencies may not be a trader’s first choice to include in a strategy, but they have gained some popularity among traders that would like to diversify their currency trading portfolios.

Most emerging markets are large in terms of consumer figures which makes them attractive to investors and forms a close relationship between their currencies and major currencies such as the US dollar and the euro.

In this article, you will have the opportunity to read more about the bond between some of the most popular emerging market currencies such as the South African rand (ZAR), Mexican peso (MXN), Turkish lira (TRY) and the US dollar (USD) as well as what the forecasts are for this year.

US Dollar Strengthens In The Beginning of 2024

A poll by Reuters, published on February 7th, showed that emerging market currencies could have a hard time gaining ground against the US dollar this year. The reason is that financial data coming from the US reflect an economy that has faced the impact of the tight monetary policy implemented by the Fed, but still remains resilient, especially in the labour market sector.

Although inflation has come down in the last months, strong reports related to a variety of economic sectors seem to push back any rate cut expectations by the US Federal Reserve (Fed). The CME Fedwatch tool shows that there is only a 20% (at the time of writing) chance of lowering borrowing costs in the next Federal Open Market Committee (FOMC) meeting scheduled for March 20th.

As a result, the US Dollar Index (DXY), which measures the strength of the US currency against a basket of six major currencies, hit a three-month high in the first week of February, up by 2.68% since the beginning of the year. The dollar is on track for one of the best yearly beginnings in the last decades.

South African Rand: Stalling Reforms Hurt Economy

It is no secret that the South African economy has faced problems as reforms have stalled and extensive power cuts hurt productivity, a common issue due to the lack of the grid’s maintenance.

Fitch Ratings forecasts real GDP growth to accelerate to 0.9% in 2024 and 1.3% in 2025, from an estimated 0.5% in 2023. However, its analysts emphasized on the economy’s critical issues in their report saying: “South Africa's 'BB-' IDR is constrained by low real GDP growth, a high level of inequality, a high and rising government debt-to-GDP ratio, and a modest path of fiscal consolidation. Growth is hampered by power shortages that are expected to continue in the near to medium term, although at a lower magnitude than in recent months, and by a struggling logistic sector.”

Nedbank’s economists expect the South African rand to remain under pressure until local elections take place and the fiscal trajectory have been resolved. The South African Rand fell against its major rivals in 2023 due to global factors, but domestic influences and political problems could play a significant role in 2024. A Nedbank report suggested that the South African Reserve Bank (SARB) could start cutting rates in July and added that “SARB could bring the first cut forward to May if the rand holds steady around the elections and the US starts its monetary easing earlier than most expect.”

Analysts speaking to Reuters reporters noted that “an extended surge in the U.S. dollar may have driven some of the (rand's) weakness, but SA has done itself no favours and will not stand out as a currency to buy unless the state takes dramatic reform action.”

Mexican Peso: Presidential Elections Could Cause Volatility

Just as the US elections are due on November, Mexico has its own presidential elections scheduled for June 2nd. Mexico has emerged as the leading source of goods imported to the United States, overtaking China for the first time in the last twenty years. According to the US Department of Commerce, the total value of goods imported from Mexico surged by 5% in 2023.

According to ING analysts, the Mexican peso is one of the currencies that stand out from the emerging markets group. They note in a report that “however, Mexico currently has very high real rates – 6% using current inflation – and a modest reduction looks unlikely to do too much damage. At the same time, MXN price action shows it is far too early to miss out on 11% implied yields in the Peso on the threat that Donald Trump may or may not be elected president in November. We are still very positive on the Peso.”

Pimco’s analysts are optimistic regarding the Mexican peso noting that “the fundamentals will dwarf any sort of near-term volatility for us. We zoom out a little bit and take a look at the more fundamental parts of the Mexican story. Whilst there might be some volatility around elections, the fundamentals are still very good.”

Commenting on the Bank of Mexico interest rate plans, Commerzbank’s analysts said: “The real economy is now showing clear signs of the impact of high interest rates. Depending on whether there is more or less evidence today that rate cuts are imminent, the Peso could come under pressure. But even if there are no hints, a first rate cut in March does not seem unlikely at the moment, given the developments in core inflation and the slowdown in economic growth. Unless, of course, inflation gets out of control again.”

Turkish Lira: More Monetary Policy Tightening On The Way?

As Turkish political authorities have interfered with the decisions of the Central Bank of The Republic of Turkey (CBRT) regarding monetary policy, the local economy is still in a spiral of unprecedentedly high inflation figures.  

In its quarterly report, published on February 8th, the CBRT has kept its inflation forecasts for 2024 and 2025 unchanged at 36% and 14%, respectively. The annual inflation in Turkey accelerated from 64.77% in December 2023 to 64.86% in January 2024, according to the latest official data.

Last week, the Turkey’s central bank Governor, Hafize Gaye Erkan, resigned after less than a year in the job and was replaced by Fatih Karahan. The new Governor vowed to preserve the tight monetary stance until inflation falls to levels consistent with the set target. 

In his remarks, Karahan said: “We will be watchful of inflation expectations and pricing behavior. We stand ready to act in case of any deterioration in the inflation outlook. While our policies are starting to yield results, we will maintain our policy stance until we achieve permanent price stability, lower inflation on the projected path, and bring sustainable price stability to our economy in the medium term.”

The appointment of Fatih Karahan, a former US Federal Reserve economist, has raised the possibility of further tightening with Deutsche Bank economists suggesting there’s room for another 250 or even 500 basis points of front-loaded tightening, according to a Bloomberg report.

ING’s analysts said in a report that “the TRY is one of the very few emerging market currencies with positive total returns against the Dollar this year. With cross-market volatility low, it looks like investors are keen to take on Turkish foreign currency risk and try to receive rates. We tend to cautiously favour these strategies too.”

Emerging Market Currencies Trading With Admirals

Trading currencies is not only limited to the major currencies such as the US dollar, euro and the Japanese yen, but strategies can include pairs based on emerging market currencies. Whether beginner traders trade major, minor or exotic currency pairs, they have to deal with the lack of knowledge and experience handicap.  

Delving into educational materials such as articles, how-to guides, attending seminars or watching online webinars gives you the opportunity to get familiar with how experienced traders see trading and how they react when conditions are volatile. Knowledge is power when it comes to trading, especially when your funds are at stake.  

Learning more about risk management when trading is important for beginner traders. Market volatility can be high, and lack of experience can be an obstacle for every beginner. Risk management tools such as stop loss and take profit orders can mitigate risks when used properly. These types of tools are available in the most popular trading platforms so beginner traders can practice using them before making them a part of their trading strategies.  

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.