Article / 05 February 2018 at 12:46 GMT

EM FX Weekly: A reversal of fortune — #SaxoStrats

Head of FX Strategy / Saxo Bank
  • EM currencies likely to underperform if risk-off continues
  • India the highest-yielding Asian EM currency in our model at just over 6%
  • Russian Central Bank rate decision due Friday, February 9

Russian Central Bank
The Russian Central Bank: We focus on the ruble this week as the central bank may be reaching a crucial point in terms of its ability to cut rates. Photo: Popova Valeriya /

By John J Hardy

This is the first beta of a new weekly publication offering perspectives on emerging market currencies, with particular focus on carry-adjusted performance for higher-yielding currencies as carry is an under-appreciated portion of returns in EM investments, particularly in the currency itself. 

The spot exchange rate for high yielding EM currencies, meanwhile, relative to past levels provides little or no value due to the drift from higher yields and inflation.

Reversal of fortune this week in risk appetite and EM

It’s no surprise that the vertical rally in risk appetite marking the first weeks of 2018 was supportive of emerging market assets and currencies as well. The last week, however, saw a significant bout of consolidation in the prior regime of a virtual melt-up in risk assets. This is easily visible in the chart below that shows the weak performances of many EM currencies over the last week. As well, keep in mind that our EM performance benchmarks are against the most important global reserve currency, the US dollar, and it is a weak US dollar as much as strength anywhere else that is providing the majority of returns. 

Take the euro-heavy Dollar Index, which is down about 3.5% since the turn of the calendar year, as of this writing. By that measure, EM currency performance on the one-month horizon is not particularly impressive relative to other non-USD major currencies.

Chart: Global Risk Index

Our first graphic focuses on an index we have created of global risk – our Global Risk Indicator, as history has shown that risk appetite is a (even the) key driver of emerging market returns. The indicator offers a perspective on the short-term level and momentum of risk appetite. The index employs a rather short time window, which allows a more rapid response to changing conditions. Because of the nature of return distributions on risky assets and the use of volatility components in our Global Risk indicator, there is a strong negative skew in the distribution that is readily evident on the chart. 

At present, the latest bout of risk-off has seen the indicator fall to the zero level and slightly below after a solid period of strong risk appetite. EM currencies and markets will likely underperform if Global Risk continues to deteriorate – and we have some concerns on that front, noted below in the outlook. 

EM have been rather lightly impacted so far as the US dollar – a key aspect of global liquidity – has remained relatively weak. 

Global Risk Index
Source: Saxo Bank 

EM currency outlook

We note the recent correction in risk appetite with considerable concern, especially given the simultaneous correction in risk appetite and bond market weakness (as global bond yields are also rising). This is tightening liquidity and risks impacting risk spreads more prominently in emerging market bonds as well. 

Over the last week, the US 10-year yield pulled significantly higher, especially in the wake of the rather non-eventful, if slightly hawkish, Federal Open Market Committee statement this Wednesday and the Friday report of strong US Average Hourly Earnings growth in January. 

If the long end of the US yield curve continues to lift aggressively, and particularly if the USD starts to rise on top of an environment of generally rising volatility across asset classes, this could weigh increasingly on EM currencies and assets.

EM currency performance: recent and longer term, carry-adjusted

The chart below shows that virtually all EM currencies were derailed over the last week by a bout of weak risk appetite (a few of the currencies shown are non-G10 but arguably not EM, but these are kept in the universe for perspective). 

In our universe, only the renminbi managed to eke out a gain for the week, but over the last month most are still higher versus the generally weak greenback. 

(Please note that the carry-adjusted performance is a best effort exercise based on available data and does not include any trading cost estimates.)

Weekly spot and one-month carry-adjusted EM FX returns versus USD:
EM FX performance
Source: Saxo Bank 
Chart: three- and 12-month carry-adjusted EM FX returns versus USD

The chart shows that most EM currencies, adjusted for carry, have advanced significantly against the US dollar over the three- and 12-month periods, with the latter providing a very supportive backdrop of strong global risk appetite and a weak US dollar. 

The South African rand has been the star performer of the last quarter owing to the election of Ramaphosa to head the ANC and that this will lead to the mismanaged South African government and economy to regain its feet. 

(Please note again that the carry-adjusted performance is a best effort exercise based on available data and does not include any trading costs estimates.)

EM FX performance
Source: Saxo Bank 

Current one-year rates

The highest yield Asian EM currencies in our universe are shown below. India is the highest yielder at just over 6%. India maintains a relatively high policy rate to keep inflation under control and as its trade dynamics have turned negative over the last 12-18 months (widening deficits).

Top five carry currencies
Source: Saxo Bank 

The one-year yields of the highest yielding ex-Asia EM currencies in our universe are shown below. Turkey is far and away the highest yielding currency, having been forced to raise rates to defend against capital outflows and high inflation.

One-year yields
Source: Saxo Bank  
Spotlight currency this week: Russian ruble (RUB)

Note that the Russian Central Bank’s latest rate decision is up February 9 and consensus expectations are for a 25 basis point cut to the headline rate, which would take the rate to 7.50% after chopping from 10% during 2017.

The Russian ruble has recently slowed its progress higher versus a very weak US dollar after the Russian finance minister made it very clear that Moscow intends to take advantage of the strong ruble to significantly accelerate purchases of foreign currency. The recent comments have come as USDRUB is within hailing distance of its 2017 low. 

This intervention comes despite the oil price reaching record levels in ruble terms as the Russian economy and certainly inflation are far from showing signs of overheating, with the country only just emerging from very weak to negative growth over the last couple of quarters.

The Russian central bank sliced its policy rate by 50 basis points at the December meeting, more than the majority were expecting, and this is likely a component of official efforts to stem excess ruble strength. At these levels the authorities are more interested in currency stability than further strength, so upside may be limited. 

If strong risk appetite returns, however, Russian authorities will have quite a fight ahead of them as real interest rates of +5.0% are very attractive. That high real rate will inevitably fade as the central bank continues to cut and as the effects of prior currency strength begin to fade.

Chart: EURRUB and USDRUB and Russian one-year swap rate (orange)

Most of the recent ruble strength has been down to a weak US dollar (USDRUB shown in black). Against the EUR, ruble has only gained in carry terms (the chart shows the spot exchange rate) since mid-last year. 

The Russian central bank is likely running out of room to cut rates in the year ahead. If oil prices retreat again, it would likely weigh on the currency and begin to increase inflation for imported goods, while significantly higher oil prices might begin to heat up the economy on top of the stimulus of many rate cuts over the last year.

Source: Saxo Bank  

Stay tuned for more ...

This is the first beta release of this publication and we will be refining and adding more features in future editions. Please feel free to contact me with any questions or comments on what you would like added to future editions.

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

06 February
stas_ms stas_ms
Good afternoon. Tell me, does the exchange rate of the total debt and interest on existing loans denominated in U.S. dollars. I wonder where you can look at the data on the availability of free currency in circulation in the Russian Federation, is there a deficit or Vice versa we have a surplus? Thanks in advance.
Relevant articles for you


The Saxo Bank Group entities each provide execution-only service and access to permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on or as a result of the use of the Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer
- 沪ICP备13028953号-1

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail