By Win Thin
Despite pockets of relative outperformance, EM currencies have fared terribly this month and bring to mind parallels with the great EM sell-off of 2008-2009. During that period, the worst performing EM currencies vs. USD were PLN (-45%), HUF (-40%), TRY (-35.5%), MXN (-35%), KRW (-35%), RUB (-34%), BRL (-34%), and ZAR (-31%). For the current period since August 1, when this latest EM bloodbath really started, the worst performers are ZAR (-15%), BRL (-14%), PLN (-13.5%), MXN (-12%), RUB (-12%), HUF (-12%), INR (-9%), and KRW (-9%). This is virtually the exact same group of underperformers. Furthermore, the numbers suggest that there is still a lot of potential downside ahead for EM currencies if things continue to deteriorate in the euro zone. Again, like 2008-2009, the impetus for the sell-off is not coming from within EM, but from negative developments in DM.
While a revisiting of the 2008-2009 lows seems too aggressive right now, we are setting our sights on the May/June 2010 levels hit when EM sold off on the first Greek blow-up. Those 2010 levels for the major EM currencies compared to current levels are summarized in the following table. We have also added the 2008-2009 levels as well for comparison’s sake. Bottom line is that while EM has held up pretty well so far, the deepening crisis in the euro zone is likely to lead to continued weakness.
Source: Bloomberg
As the table shows, despite the August/September sell-off, much of EM FX remains stronger than in May 2010. Of the major EM currencies, the ones that are at or have surpassed those 2010 highs are USD/MXN, EUR/HUF, EUR/PLN, USD/TRY, and USD/INR. Others have held up better to varying degrees, and we continue to believe that EM countries with strong fundamentals will continue to outperform those with weak fundamentals. We saw back in 2008-2009 that of the eight worst EM performers, five of them had fundamentals that we rated in our FX model as weak (TRY, PLN) or very weak (HUF, KRW, ZAR). One had neutral (MXN) fundamentals and the other two had strong (BRL) or very strong (RUB) fundamentals. On the other hand, during that same 2008-2009 period, of the eight best EM performers, five of them had fundamentals that we rated as strong (TWD, MYR, PEN) or very strong (CNY, SGD). Two had neutral (ARS, THB) fundamentals and one had very weak (PHP) fundamentals. We are seeing similar trends in EM FX performance in Q3, and will be summarized in our upcoming FX Quarterly next week.
It is clear that ongoing events in DM will continue to drive EM currencies lower for the foreseeable future. We simply have not seen any signs of closure or containment ahead with regards to the euro zone debt crisis. It appears that Greece will get the next tranche of aid from the troika, which would likely take the country through year-end. While markets look for a likely Greek default in 2012, the banking sector repercussions and contagion on other euro zone members remains unknown. As such, ongoing uncertainty is likely to make Q4 a terrible quarter for EM. This is especially ironic since growth prospects and economic fundamentals in EM for the most part remain very good when compared to DM. The price action this past month simply underscores the fact that no matter how good EM fundamentals are, there IS no decoupling to be had between EM and DM.