22 July 2018

Sharp Drops In Currencies Hint At Spreading Volatility

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The currencies of places as diverse as Russia, Hong Kong and Kazakhstan slid last week, an alarming sign to some investors who worry that the geopolitical volatility affecting U.S. stocks is spreading to other markets.

Hong Kong’s dollar hit the lowest level allowed under a more than three-decade-old U.S. dollar-peg agreement, forcing the de facto central bank to step in to defend the currency and stabilize it. Russia’s ruble fell amid increased U.S. sanctions against the country and concern about a U.S. strike on Syria, a decline that also contributed to a fall in Kazakhstan’s tenge. Those moves came alongside a relatively calm week elsewhere, in which the Dow Jones Industrial Average rose nearly 2% and the U.S. dollar was little changed against a basket of currencies.

Currency markets have been steady this year, and some worry that investors aren’t prepared for major global shifts, including tightening monetary policy in the world’s biggest economies, that could threaten a yearslong emerging-markets rally.

This week, investors will also confront news that the U.S., U.K. and France launched missile strikes on Syria in retaliation for a suspected chemical-weapons attack. While officials indicated there aren’t currently plans for more strikes, the attack is likely to add to tensions between the U.S. and Russia—which supports the Syrian regime—and could inject more volatility into emerging-market assets and prices for oil and other commodities that many of those nations export.

When geopolitical uncertainty rises, foreign-exchange investors tend to pull back on emerging-market currencies and flock to those considered safe, such as the Japanese yen.

After a strong start to the year, emerging-market currencies have slipped in recent weeks. After a strong start to the year, emerging-market currencies have slipped in recent weeks.

Some investors and analysts worry that foreign exchange could become the next arena in a burgeoning trade conflict between the U.S. and China. China’s yuan has thus far been resilient to the trade spat, but analysts fear a further ratcheting in tensions could drag down both the Chinese currency and a broad range of other Asian currencies.

A JPMorgan Chase & Co. index that tracks expected volatility in emerging-market currencies rose last week to its highest level since February’s market rout. Another JPMorgan metric for major currencies—such as the dollar and euro—continued to fall, suggesting that volatility remains confined to the more sensitive currencies of developing and emerging-market nations.

Investors say one major threat to currency-market stability is the growing trade skirmish between the U.S. and China. Although tensions have eased since earlier this month, when the world’s two largest economies threatened to impose tariffs on billions of dollars of each others’ goods, few expect the calm to last.

Some investors fear that China could retaliate against U.S. protectionist policies by devaluing its currency, which has risen about 10% against the dollar over the past year.

“If China were perceived to be signaling it wanted a weaker yuan…that’s a pretty effective way of offsetting any trade gain the U.S. might try to achieve through tariffs,” said Brad Setser, a senior fellow at the Council on Foreign Relations.

Currencies vulnerable to a yuan devaluation include the South Korean won, Singapore dollar and Thai baht, as well as those of other export-dependent Asian nations, analysts said.

Eswar Prasad, a professor in trade policy at Cornell University, said any effort to devalue the yuan could quickly backfire on China. Its devaluation of the yuan in 2015 sparked a global market selloff and set off a wave of capital outflows that China spent around $1 trillion in reserves trying to halt.

Devaluation “would be a tool that could actually hurt the Chinese a lot more than it would hurt the U.S.,” said Mr. Prasad. “It would really set the Chinese back in terms of what they’re trying to accomplish with financial-market opening.”

The rise in global policy and trade tensions has roiled other emerging-market currencies. The Russian ruble tumbled 6.8% against the dollar last week after the Trump administration announced new sanctions against government officials and business magnates in Russia. Kazakhstan’s tenge dropped 2.3% against the dollar, highlighting fears that the ruble’s decline will upend trade between the neighboring countries.

Meanwhile, the Turkish lira fell 1.3% last week as the emerging-market volatility sharpened investor concerns over the health of that nation’s economy.

A measure of expected volatility in emerging market currencies has risen.A measure of expected volatility in emerging market currencies has risen.

The declines mark a reversal from a months long rally that took emerging currencies and stocks to multiyear highs, as investors brushed off uncertainties surrounding global trade and politics to focus on strong economic growth in those nations. An MSCI index of emerging-market currencies has gained around 2% this year, while its benchmark emerging-market stock index has risen 1%. That compares with the S&P 500’s 0.7% decline and the Stoxx Europe’s 2.6% fall.

A jump in volatility could also pressure countries whose currencies remain tied to the dollar, such as Saudi Arabia and Qatar. Pegged currencies are often allowed to trade only at a specific rate or within a tight band, and volatility can make upholding those levels more difficult as other factors—such as investor flows in and out of the country—buffet the currency.

Many developing nations linked their currencies to the dollar decades ago in a bid to insulate their economies from volatility. But the dollar’s surge from 2011 to 2016 and a multiyear commodity-price rout forced many countries to cut those ties as they became too expensive to maintain.

In 2014, Russia’s central bank began taking steps to allow the ruble to float freely as the country’s economy came under stress. Countries including Nigeria, Egypt and Kazakhstan have abandoned or loosened their ties to the dollar recently.

“Pegs don’t fare very well in a market that’s volatile,” said Mark McCormick, North American head of foreign exchange strategy at TD Securities. As markets become less stable, “the pegs will be challenged,” he said.

Click here for the original article from The Wall Street Journal.

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