Goldman Sachs On EM FX

The US bank on EM FX and sensitivity to US yield moves. Recovery in EM FX is likely to need relief from the US yield curve or yields being more driven by growth (rather than inflation data), see below for details.

Goldman Sachs: "The EM FX appreciation in early April – driven by a broadening of cyclical pricing including to commodity markets – was short lived. Even with some recovery this week, most EM currencies are still weaker versus the Dollar since the release of the March US CPI print. And the focus has shifted squarely to the drivers and the speed of US yield moves and its impact on the broad Dollar, including on USD/CNY. As we have discussed previously, the vulnerability of EM FX to US rates moves is highest when (i) US yields are rising due to a “hawkish policy shock” and this has a negative impact on broader cyclical pricing and (ii) yields rise faster than about a 20-30bp/month 'speed limit'; both of which have taken place over the last few weeks. This combination is typically more negative for the riskier higher-yielding currencies, especially if the US yield curve is also bear steepening. And, in line with this, high-carry currencies (especially MXN and COP) have underperformed their typical betas the most since the US CPI release, which represents a shift from the more upbeat sentiment towards carry of earlier in the year.

In contrast, the degree of underperformance relative to other market variables most recently has been smaller in the currencies that had already more clearly underperformed in Q1, including EM Asia currencies and CLP. For CLP in particular, we think this shift in sentiment is consistent with the sharp rally in copper prices and a less-dovish central bank reaction function. With this mind, we think a recovery of EM currencies will require some relief from the US yield curve (as we are seeing today) or require that higher yields are driven more by growth than by the inflation data. The move in US rates has also led to a sharp repricing in EM rates, and the extent to which EM central banks validate this repricing will be an important differentiator in FX performance. This has already played out this week with Bank Indonesia (BI) surprising with a rate hike and the MNB in Hungary slowing the pace of cuts citing deteriorating international sentiment. Elsewhere in Asia, we think the BoK, CBC and BOT will be more tolerant of a weaker currency than BI. And, in the CEE region, we think the Czech National Bank is likely to continue with the current pace of easing, especially as the ECB is a stronger anchor than the Fed, keeping CZK firmly in the funder camp. In contrast, the Bank of Mexico should be the most attune to Fed pricing, which will keep the carry buffer in MXN elevated."