EM FX: BNY says real rates restrict downside

Emerging Market FX Carry Trades Show Strength Amid Geopolitical Tensions

Geoff Yu, EMEA Macro Strategist at BNY, observes that despite ongoing unrest in the Middle East, carry trades in emerging market currencies remain robust. Among twelve high-yielding currencies, only the Indian Rupee (INR) and Romanian Leu (RON) are currently underheld. Yu attributes this resilience to strong real interest rates and the credibility of emerging market central banks, while also noting the possibility of the Federal Reserve resisting rate cuts.

Real Interest Rates Support EM Currency Strength

Out of a dozen high-yield emerging market currencies with sufficient data, only INR and RON have recently become underheld. Yu emphasizes that real interest rates are the primary driver behind the sustained appeal of FX carry trades. Although global inflation is expected to rise, most EM central banks have built up enough policy credibility to avoid aggressive easing, even as economic growth faces headwinds.

Fed Policy and Central Bank Actions Shape Market Dynamics

Another factor influencing EM currency performance is the potential for the Federal Reserve to delay rate cuts. Bank Indonesia’s recent decision highlights this dynamic, as the Indonesian Rupiah (IDR) is at risk of joining INR and RON in the underheld category. The bank’s move focused on bolstering external stability, intervening to stabilize the currency, and attracting foreign investment.

Yu suggests that most EM central banks are expected to adopt similar strategies, which explains why the majority of high-yield currencies continue to see net buying activity.

Fiscal Concerns Impact Turkish Lira

The Turkish Lira (TRY) is currently experiencing the most pronounced selling pressure, despite elevated nominal interest rates. This points to rising fiscal worries, especially if government subsidies become more costly amid ongoing conflict. Central banks are likely to caution fiscal authorities that markets have little tolerance for large-scale interventions in energy prices, which helps explain the prevalence of austerity and rationing measures in many emerging and frontier markets.

This article was produced with assistance from an AI tool and reviewed by an editor.