EM Currencies May See Futher Declines on Fed, Rising U.S. Bond Yields

(Bloomberg) -- Emerging-market currencies may see further declines after the Federal Reserve signaled interest-rate hikes could be more aggressive than expected, eroding the allure of riskier assets.

MSCI Inc.’s gauge of developing currencies slipped 0.3%, its biggest drop in three weeks, after earlier dropping as much as 0.4%. The 10-year Treasury yield briefly topped 1.75%, approaching its 2021 high during early U.S. day trading. 

Minutes from the Fed’s December meeting showed policy makers were considering tightening policy earlier than anticipated and weighing steps to shrink its balance sheet. Concerns about a resurgent dollar, accelerating inflation and the latest Covid-19 variant were already weighing on sentiment toward emerging markets. 

Rapidly rising Treasury yields “make EM assets less appealing,” said Piotr Matys, a senior currency strategist at InTouch Capital Markets Ltd. in London. “EM currencies whose central banks haven’t started raising interest rates or their rates are still negative in real terms could be particularly vulnerable.”

The Turkish lira, Thai baht  and Malaysian Ringgit were among the biggest losers on Thursday. Still, the market’s risk aversion ebbed during the U.S. trading day, with the South African rand, Russian ruble and Brazilian real advancing the most against the dollar. 

“The adjustment will end eventually, and most emerging markets have already started hiking rates,” said Cristian Maggio, the head of portfolio strategy at TD Securities. “I expect the market to find an equilibrium point and after the first one to two hikes from the Fed, we may see EM FX return to a stronger performance.”

MSCI’s index of developing-nation stocks fell 0.5%, adding to a 1% drop from Wednesday. 

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