Big Moves, Important Levels

EUR/USD Parity and EMFX

Watching the EUR/USD cross trying to break parity is absolutely mesmerizing, but this is not the only significant FX level that is (or maybe?) about to be breached (or already breached). The J.P. Morgan Emerging Market Currency Index¹ is now trading below 50.0 (see chart below). The Hungarian forint moved above 400/euro. The South African rand is trading above 17.0/U.S. dollar for the first time since the pandemic (September 2020). The Chilean peso made a big move above 1,000 against the U.S. dollar this morning, pressured by the outlook for copper and the domestic policy agenda. Argentina’s alternative “blue chip” exchange rate breached the 300/U.S. dollar threshold, and the Romanian lei is “within walking distance” to 5.0/euro.

EMFX Flexibility – Policy and Market Responses

From the macroeconomic perspective, a weaker but more flexible exchange rate – especially when accompanied by credible rate hikes – is not such a bad thing. It acts as a shock-absorber (=no waste of international reserves on futile interventions), and paves the way for the eventual external adjustment. Note that the Chilean central bank refused to intervene on the FX market – despite a sizable depreciation move. However, FX weakness in the current environment can add to inflation pressures in emerging markets (EM), forcing central banks to extend tightening cycles – often at the expense of growth. The local swap curve, for example, is now pricing in an extra rate hike in Brazil. And, of course, from the market’s perspective, weaker EM FX added (a lot) to year-to-date losses in local debt (J.P. Morgan’s GBI-EM Index, USD unhedged).

Extending EM Tightening Cycles

Circling back to policy responses, Hungary raised its base rate by 200bps this morning, bringing it to the same level as the 1-week deposit rate (which was increased by the same amount last week). Hungary’s rate hikes’ “acceleration” is happening in sync with announced fiscal tightening, albeit the currency and the local bond market are yet to be convinced that policy adjustment is credible after a massive pre-election spending spree. Central banks in Chile and Korea will be meeting tomorrow, and both are expected to deliver 50bps rate hikes. In the case of Korea, this would be a welcome move (headline inflation is currently around 6%, and expected to drop to low single digits in H1-2023). In the case of Chile, the market might be disappointed by “mere” 50bps, considering it insufficiently hawkish against the backdrop of double-digit inflation. Stay tuned!

Chart at a Glance: EM FX – Crossing Important Levels

Source: Bloomberg LP