Where next for emerging market currencies?

Since the November 2016 US elections, the US dollar had a two way ride. The wave of US dollar strength had been driven by the twin engines of fiscal and monetary policy in late 2016. The strong growth outlook kept the market on a buying frenzy of the US dollar and equities alike, selling everything including emerging market currencies. The USD index, which tracks the US dollar against six major currencies, had a good run from the depths of 98.00 in early November 2016, peaking at 103.30 just before the turn of the year. Taking the worst hit amongst emerging market currencies in the region had been the Malaysian ringgit (MYR) and the South Korean won (KRW), each shedding more than 6.0% against the USD between the US elections and the last trading day of 2016.

Certainly we have seen President Donald Trump deal more harm than good for the USD since his inauguration in late January. Besides jawboning down the currency, the absence of his pro-growth promises such as tax cuts and infrastructural spending have also seen patience running low for markets. Although this matter remain shrouded by uncertainty, a good proportion of the market appear to be holding on to the belief that we may receive the fiscal boost, evident in equity market performances.

On monetary policy, the Federal Reserve had unexpectedly drummed up Fed hike expectations and delivered a hike in their March 14-15 Federal Open Market Committee (FOMC) meeting. The main concern for markets, in which the path that future rate hikes will take, however yielded a considerably dovish response from policymakers.

A USD selling spree was seen post-FOMC for the market that had been anticipating a more aggressive stance by the Fed in light of the recent rhetoric. That said, in line with the fiscal policy implications, the longer term trend for the USD may still be tilted to the upside. The Fed currently anticipates two additional hikes for 2017 and a further three in 2018 in the journey to the 3.0% long term funds rate, decidedly departing from the more accommodative stance previously and providing room on the upside for the USD.

Emerging currencies trend

2017 brought forth a reversal in the situation with the US dollar erasing some of its gains. Emerging market currencies managed to eke out gains against the USD as a whole. A broad uplift in production and trade conditions for emerging markets, coupled with the toning down of trade concerns, previously ignited by President Donald Trump, has revived currencies and equities alike for emerging markets.

While we are set to receive an upgrade to the number of Fed hikes this year, the improvement in economic conditions has had and could continue to help emerging markets avoid a surge in capital outflows. A prominent example would be Asia's anchor, China, finding official manufacturing PMI numbers sustaining above 51.0 since Q4 last year and reasons to tighten monetary policy.

All in all, in the longer term we could be seeing the USD still on the up move, though the pace at which the USD tick up may be considerably moderate with global markets playing catch up in this reflation theme.