Bloomberg
Tokyo


This month’s rally in higher-yielding currencies is in danger of snuffing itself out.
The Australian dollar to the South African rand have strengthened in the past three weeks after the Federal Reserve held off raising interest rates in September, citing global market turmoil. The decision preserved their yield advantage over the US, fuelling the currencies’ recoveries from this year’s lows.
Here’s the catch: Those gains are starting to contribute to the sort of calm policy makers would like to see before they act.
That may rekindle the threat of a Fed liftoff. And such a prospect risks derailing the recovery, whipping up volatility, and starting the cycle afresh.
“If markets become complacent again, expecting the Fed will just keep interest rates lower for longer, they’re actually creating the conditions for the Fed to go ahead and start normalising monetary policy,” said Mansoor Mohi-uddin, a senior markets strategist at Royal Bank of Scotland Group in Singapore. “That’s why I remain cautious about commodity currencies and emerging markets.”
It’s a paradox that saw Australia’s dollar plunge to a six- year low of 68.96 US cents last month, before kicking off October with a nine-day winning streak - its longest rally since 2009 - as futures showed the odds of a Fed liftoff by December receding.
Adding to the sense of renewed stability, a gauge of emerging-market currencies has recovered almost all its losses since China unexpectedly devalued the yuan on August 11, while an index of volatility has retreated from a 3 1/2-year high.Higher-yielding currencies have managed to rally even as the global economic outlook darkened.
The International Monetary Fund cut its 2015 growth forecast to 3.1% this month, from 3.3% in July, citing a slowdown in emerging markets driven by weak commodity prices.
Australia’s dollar extended this month’s advance to almost 4% after data yesterday showed China’s economy slowed less than economists predicted. South Africa’s rand climbed to an almost two-month high, after rebounding - along with the Turkish and Brazilian currencies - from record lows reached in September.
New Zealand, whose 2.75% benchmark rate is the highest among all major developed economies, saw its kiwi transformed into the best-performing major currency over the past month, from being the biggest rich-world loser in the first nine months of the year.
JPMorgan Chase & Co’s Emerging-Market Volatility Index has dropped 2 percentage points from its peak last month of 13.1%, as swaps traders cut their expectations for the level of the Fed rate a year in the future to as low as 0.43% on October 15, the least in 12 months.
“Emerging-market and commodity currencies do seem unhealthily reliant on Fed procrastination,” said Sean Callow, a currency strategist at Westpac Banking Corp in Sydney. “The very factors that caused the Fed to hold off on a rate hike in September are those which should worry emerging-market and commodity currencies the most.”
Minutes of the Federal Open Market Committee’s September 16-17 meeting showed policy makers put off the first rate increase since 2006 amid concern China’s slowing growth would spill over to other developing nations.
The risk is that a Fed rate move would add to turmoil in emerging markets, driving the dollar higher and creating an additional drag on the US economy. Fed officials referred to the greenback 24 times at their last gathering, from 12 mentions in the July minutes, and 10 in March.
The US central bank delayed raising interest rates to “take time to appraise” slower growth in China, Fed Vice Chairman Stanley Fischer said October 9, acknowledging global developments now weigh more heavily on monetary policy than was traditionally the case.
The Fed’s trade-weighted dollar index has retreated 2.3% since climbing to a 12-year high of 121.18 last month - and the greenback has weakened against all its 16 major peers this month.Futures traders have all but ruled out the prospect of rates rising from near zero at the FOMC meeting this month. The odds of an increase by year-end dropped to as low as 27% last week, from 64% before the decision to leave policy unchanged on September 17.
The IMF’s unusual step of recommending last month that the Fed delay liftoff underlines how vulnerable developing economies are to higher US rates, according to Philippe Rakotovao, global head of debt and credit-markets trading, sales and syndication at Credit Agricole’s corporate and investment- banking unit in London.
“Emerging markets are very leveraged and therefore highly dependent on the dollar,” Rakotovao said in an interview in Tokyo. Tighter policy “definitely” won’t come this year, he said.