An illuminated euro currency symbol is projected on to the European Central Bank (ECB) headquarters in Frankfurt, Germany. (Photographer: Martin Leissl/Bloomberg)

Low Emerging-Market Volatility a Mirage to ING as Fed Looms

(Bloomberg) -- The stability in emerging-market currencies could be the calm before the storm, according to ING Groep NV.

A gauge of expected price swings in developing-nations exchange rates is near the lowest level since 2014, unruffled by the political turmoil in the U.S. and Brazil, and concern over China’s growing debt pile that led to a cut in its credit rating. The Federal Reserve looks set to raise interest rates in June, while the European Central Bank may also take steps toward unwinding stimulus.

“This is a goldilocks environment for EM FX markets, though volatility looks too low ahead of ECB and the Fed,” Viraj Patel, a London-based foreign-exchange strategist at ING, said by email. “Both central banks could lead with changes to their respective balance sheet policies and this could create a perfect storm at the long-end of global markets.”

While European Central Bank officials have been debating when and how to start paring stimulus and increase rates, researchers at the authority warned last month that emerging markets should brace for increased volatility as the world’s major central banks adjust the size of their balance sheets. Still, a JPMorgan Chase & Co. index of implied volatility has resumed declines after rebounding from a 30-month low reached on May 16.

Patel’s skepticism isn’t shared by money managers and strategists at Aberdeen Asset Management, Amundi Asset Management and Mizuho Bank Ltd. The slow pace of borrowing-cost increases in developed markets and improving economies for many emerging countries will continue to draw yield-hungry investors to riskier assets, some of them say.

“With EM current accounts now at their best level in almost 10 years on average, we expect the environment to remain accommodative even if Fed continues to normalize interest rate,” said Abbas Ameli-Renani, Global EM Strategist at Amundi in London. “Historical observations show that as EM current-account balances improve, the sensitivity of their assets to developed-market interest rates declines.”

‘Bad Headline’

For Edwin Gutierrez, the London-based head of emerging-market sovereign debt at Aberdeen Asset, the possible moves by the Fed and the ECB “are pretty much well telegraphed.”

“It’s gonna take some pretty hawkish commentary to spook the market,” he said. The stability seen in emerging-market currencies has a lot to do with “the dollar’s weakness as the Trump reflation trade is unwound,” he said.

Minutes from the Federal Open Market Committee’s May 2-3 gathering released Wednesday pointed toward a hike as soon as the meeting in mid-June. However, the dollar weakened as FOMC voters added the caveat that “it would be prudent” to wait for evidence that a recent slowdown in economic activity had been transitory.

The JPMorgan volatility gauge has slipped 44 basis points so far this week, after climbing 64 basis points last week, the most since November.

Ken Cheung, a Hong Kong-based currency strategist at Mizuho, also cited the “collapsing” Trump trade while predicting that swings in emerging-market currencies may narrow further.

“The foreign-exchange market also digested Fed’s plan to deliver three rate hikes and shrink its balance sheet,” he said.

Even so, the somewhat muted market reaction to China’s rating downgrade by Moody’s Investors Service Wednesday seems to affirm Patel’s view.

“China is one of the many global tail risks out there -- Trumpeachment, geopolitics, potential end of global monetary easing are others to consider,” he said. “The message from markets is that we are aware of these risks, but we need to see an escalation of any one of these before becoming overly concerned. This is a risky strategy -- you’re just one bad headline away from getting caught out.”

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