Fed’s surprise hawkish tilt bad for emerging markets currencies

In the last FOMC policy meeting, seven policymakers (3 in the March meeting) indicated that they are now expecting a rate hike as early as 2022, which caught investors by surprise as they were pricing in a hike in 2024. The number of participants expecting a hike in 2023 almost doubled to 13 from 7 in March. Only 5 members are still anchored on no hikes until 2024.

 

This outlook spooked investors resulting in some weakness in financial markets. As shown in the graph below, the impact of the statement was more pronounced on the front end of the bond yield curve where real yields of 5-year and 7-year treasuries shot up. Real yields on 10-years were less responsive while those of longer bonds compressed. The improvement in yields on short bonds, even though negative, as well as the specter of tapering, spells out headwind for emerging market currencies.

 

The South African rand is not immune. However, it will be interesting to see how emerging market central banks will react to the change in global monetary dynamics. Brazil and China, have recently increased interest rates to protect their currencies. The SARB is unlikely to intervene in the currency market but should the currency weakness distort the upcoming inflation numbers, then may be forced to hike interest rates.

Source: US Treasury Department

*Today refers to real yields on the 17 June 2021.