Relative weakness of the US dollar is seen to be giving emerging markets (EM) currencies a temporary reprieve, and furthermore the risk of excessive weakness is likely to decline, according to one City analyst.
In a note to clients, Per Hammarlund, chief emerging markets strategist at Nordic bank SEB, said a rising risk of an escalating trade war, primarily between the US and China, but also between the US and Mexico and the US and the EU, is weighing on investor sentiment.
“US-EU trade tensions have stabilised for now. However, US President Donald Trump’s threat of imposing a gradually increasing tariff rate on Mexican exports to the US (if Mexico doesn’t stem the flow of immigrants through its borders) has dimmed expectations of a trade deal being reached between China and the US.”
The Chinese had already reduced the prospects of a comprehensive trade agreement with the US after US President Trump increased tariffs to 25% on $200bn worth of Chinese goods exports. Mexico had been bending backwards to accommodate US demands in the replacement of NAFTA, but was still threatened with additional tariffs, a point not lost on the Chinese.
“In short, while there have been some signs this week that Mexico may be able to avoid the new tariffs, investors are adjusting to expectations that trade tensions will persist at least throughout the remainder of US President Trump’s term in office,” Hammarlund added.
Another factor driving markets has been weak economic data. While the slowdown since early 2018 has been global, the US economy had until recently been faring relatively well compared to the rest of the world. However, recent hard data for April and May 2019 have been disappointing, causing the USD to weaken and gold prices to jump by more than 4%.
“The ECB will not change any of its policy rates on Thursday (6 June). However, it will likely take a more dovish position in its communication and lay out generous conditions for the coming targeted longer-term refinancing operations (TLTRO-III) loans. With both the US Fed and the ECB becoming more dovish, the risk of excessive EM FX weakness is being reduced.”
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