Emerging Market Currencies Hit New 52-Week Highs

From the Desk of Ian Culley @IanCulley

Markets are bracing for tomorrow’s FOMC decision – including the dollar.

That’s right – we have more indecisive action on tap. Let’s call it the knee-jerk before the knee-jerk, with a little help from today’s May CPI print. 

Interest rates, the US Dollar Index $DXY, and gold have yet to make a decisive directional move.

To be fair, most markets are trading within their respective year-to-date ranges (except the S&P 500 and Nasdaq 100, of course).

But if we turn to emerging market currencies, we don’t see any sign of hesitation…

Check out our EM Commodity Currency Index (equally weighting the Mexican peso, the Brazilian real, the Chilean peso, and the South African rand) posting new 52-week highs after violating a long-term downtrend line at the beginning of the year:

The January trend line violation raised the possibility of a bearish-to-bullish reversal.

While the recent breakout confirms the tactical uptrend underway, we still need to witness a resolution above the June 2021 highs before claiming a bullish reversal from a structural perspective. 

EM currencies are showing impressive strength. That’s undeniable. I simply want to clarify the longer-term perspective.

What does this EM currency strength mean for the everyday investor?

For starters, it’s not bullish for the dollar.

Broadening dollar weakness reflects a bearish data point (go figure) – especially considering DXY failed to reach its March pivot highs during the recent rally. And a weaker dollar bodes well for risk assets – worldwide.

Every stock market bull dreams of a falling dollar.

Sustained strength among EM commodity currencies could spill over to major developed market currencies, leading the US Dollar Index toward the lower bounds of its range and a potential downside resolution.

That’s not all…  

Besides broad dollar weakness, the bounce in EM currencies also suggests rising rates.

Notice the index and the 1o-year US Treasury yield have a strong tendency to peak and trough together. These commodity-centric currencies do well in a rising rate environment, as do the commodities underpinning their economies.

But that relationship has deteriorated since the beginning of last year (like many cyclical assets and intermarket relationships involving interest rates).

Perhaps these currencies and US yields will fall back in line, trending along the same path.

If they do, it will come at a cost to the overwhelmingly positive correlation between the US dollar and rates – a relationship that has marred markets for well over a year. 

Will EM currencies catch up to rates while US yields simply churn sideways?

That’s potentially bullish for risk assets – and it might be the most interesting takeaway from this chart.

Unfortunately, I don’t have the answer, just as I have no idea what the FOMC will decide tomorrow or next month.

But who does?

Most importantly, the market environment is changing. 

Risk-seeking behavior is re-entering the market. The US dollar is losing ground to EM currencies. And equity indexes are completing year-long reversal patterns as breath expands beneath the surface amid healthy rotation. 

These are all bull market characteristics and behavior that will only intensify if the uptrend in EM commodity currencies persists.

Stay tuned!

Thanks for reading.

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