Capital markets around the world continue to face unprecedented volatility, mainly due to regular swings in the risk appetite of fund managers, which can be explained by contradictory economic data from the US, Europe and China.
In the process, emerging market currencies are often caught in the cross-fire of repeated gains and losses for the US dollar, commonly referred to as the greenback. The latest news that upset the markets included contradictory employment data in the US, with new job openings declining, but private sector employment rising by 324,000 in July, well above market expectations.
Continued weakness in manufacturing activity in several of the world’s largest economies have also served to raise fears over economic contraction in the US and a number of European countries, whilst Russia’s military attacks on Ukraine’s grain export ports have led to a surge in wheat and maize prices.
Nonsensical US sovereign debt downgrade
The main trigger for the latest bout of risk aversion, which led to a rise in the dollar index, was the surprise move by Fitch Ratings to downgrade US sovereign debt to AA+ from AAA, citing possible fiscal problems over the next three years. Predictably, the White House responded by criticising the methodology of the ratings agency, which was based on speculative assumptions.
In an unequivocal snub of the Fitch report, US Treasury Secretary Janet Yellen noted that US Treasury bonds remained “the world’s preeminent safe and liquid asset”. This statement was justified by the immediate strengthening of the dollar index, which is regarded as a fair indication of the dollar’s value in global markets.
Since the beginning of June, foreign exchange markets were characterised by extraordinary high spreads in currency value changes against the US dollar, mainly due to the structural decline in the value of the Argentine peso, contrasting with the strength of the South African rand.
A spread of 1,240 basis points was recorded between the changes in value of these two currencies during July, confirming the importance of fiscal stability in the medium and long-term performance of emerging market currencies – a feature that South Africa enjoys, but is absent in Argentina.
The heavyweight currency division fared well in July, with the Euro, the British pound and the Japanese yen all gaining marginally against the dollar. Volatility was rife, however, with the US dollar Index ending the month slightly lower at a level of 102, but significantly higher than the 99.8 recorded in mid-month and gaining ground again during the first two days of August.
Three cheers for the rand!
The star of the currency show over the past two months was undoubtedly the South African rand. It is not often that the rand has the opportunity to bask in the glow of a number-one performance against the US dollar. In June, the rand strengthened by 5%, second only to the Brazilian real, but the following month the rand took pole position, gaining almost 6% against the greenback.
Despite the subsequent dip in the values of most emerging market currencies during the first two days of August, the rand is still in the number one spot, gaining almost 7% against the dollar, with Brazil taking the silver medal with a 6% gain and the Euro a long shot behind in third place, strengthening by 2%.
In a nutshell, therefore, July started out with a renewed risk-on sentiment amongst fund managers, but fears over another rate hike in the US and the UK swiftly put paid to this notion. Key data sets published in July continued to point to a slim possibility of a recession in the US, which led to a risk-averse market sentiment towards the end of the month, as confirmed by the 10-year US Treasury yield rising above 4% again – not far from its high of 4.23% recorded in October last year.
Higher global economic growth and lower inflation hold the keys to the next rally of key emerging market currencies. This scenario could well play out before year-end.