Emerging Market Currencies to Hold Gains or Extend Them Against Retreating Dollar

Most emerging market currencies will maintain their gains or extend them against a weakening U.S. dollar in the next six months, according to a Reuters poll of over 50 foreign exchange strategists. This is due to a flight from the dollar and U.S. assets, which has been sparked by U.S. President Donald Trump's tariffs and a deteriorating fiscal outlook.

The Dollar's Decline: A Shift in Market Sentiment

At the start of this year, emerging market currencies were expected to struggle due to expectations of U.S. economic strength and delayed Federal Reserve interest rate cuts, as well as trade tensions. However, these currencies have defied expectations and gained ground against the dollar. The decline of the dollar is attributed to Trump's broader-than-expected but erratically implemented tariffs, which have fueled recession fears and outflows from U.S. assets.

The EM Carry Trade: A Long-Term Attraction

Investors have long been drawn to the emerging market carry trade, where they borrow in low-yielding currencies to invest in higher-yielding EM ones. This year has seen high-yielders like the South African rand and Brazilian real gain around 6% and 10%, respectively. The real is expected to lose only about 2% over the next six months, while the rand is likely to trade in a tight range.

Emerging Market Currencies: Expected Gains and Losses

Some emerging market currencies are expected to continue outperforming in the second half of this year, but there are downside risks to be aware of. The Turkish lira, the weakest-performing EM currency so far this year, is projected to soften by another 8% from 39 per dollar to 42.8/dollar over the next six months. In Asia, the heavily managed Chinese yuan is expected to stay rangebound despite concerns about weak demand in its economy and a standoff with Washington over tariff policy and export controls.

Asia's Emerging Market Currencies: Steady but Modest Appreciation

The Indian rupee, Korean won, and Thai baht are all expected to gain just less than 1% by the end of November. This suggests steady but modest appreciation for these currencies. The risk of a turnaround in dollar sentiment remains a major concern for emerging market currencies.

A Long-Term View: Dollar Depreciation

While short-term risks exist, most FX strategists polled expect longer-term depreciation of the dollar. However, some analysts believe that the dollar looks too cheap on a fundamentals basis right now. This suggests that investors should remain cautious and consider buying EM currencies on dips.

Key Takeaways from the Poll

• Most emerging market currencies will maintain their gains or extend them against a weakening U.S. dollar in the next six months.
• The decline of the dollar is attributed to Trump's tariffs and a deteriorating fiscal outlook, which have fueled recession fears and outflows from U.S. assets.
• High-yielders like the South African rand and Brazilian real are expected to continue gaining ground against the dollar.
• Emerging market currencies like the Turkish lira are projected to soften further over the next six months.

Conclusion

The Reuters poll of over 50 foreign exchange strategists suggests that emerging market currencies will maintain their gains or extend them against a weakening U.S. dollar in the next six months. This is due to a flight from the dollar and U.S. assets, which has been sparked by Trump's tariffs and a deteriorating fiscal outlook. While short-term risks exist, most FX strategists polled expect longer-term depreciation of the dollar. However, some analysts believe that the dollar looks too cheap on a fundamentals basis right now.