Fragile EM currencies to watch

EM vulnerabilities are likely to become a point of interest for markets once again. The divergence of monetary policy between the US and EMs is accentuated by potential spillovers from a slower China, competitiveness concerns and disinflation pressures. This adds to the story of underperformance of manufacturing vs. services driven economies that we have noted in the past and calls for fundamental weakening in EM FX relative to the USD. 

Private/public sector balance sheet mismatches (ZAR, TRY and MYR), foreign positioning in local currency bonds (CEE, ZAR and MXN), dependence on foreign financing (CEE) and the lack of foreign currency reserves (TRY, ZAR, IDR) are likely to amplify FX moves as the USD and US rates rise.

"Further adjustment is expected in EMs that have seen sharp declines in recent months due to developing idiosyncratic stories such as the TRY, RUB and BRL. We think that further depreciation of USD/TRY towards 3.14 in Q2 16 is likely, driven by the still overvalued multilateral exchange rate (with a large EUR weight), large external financing needs, continued political turmoil and tacit government approval of currency depreciation", says Barclays.

The RUB has depreciated about 25% since mid-May, as oil prices have declined. Aside from the effect oil prices have on the RUB equilibrium value, we think the effect on Russia's fiscal picture implies a looser monetary policy stance causing higher inflation and a weaker currency. Accordingly, RUB is forecasted lower, expecting the USDRUB to weaken further to 75 by mid-2016.

"Finally, an unfolding political crisis in Brazil has severely affected the government's ability to deliver meaningful structural reforms and fiscal tightening. BCB hawkishness has been able to stem BRL weakness to some extent. However, with inflation topping out, we believe that significant currency weakness lies ahead with USDBRL rising to 4.00 by Q2 16. Higher FX hedge ratios among local corporates and high mark-to-market losses from past interventions imply that the BCB is unlikely to aggressively intervene in markets to slow down the cross", added Barclays.