RBC Assess The Impact Of U.S. FCI On EM FX

RBC “look at the developments in EM portfolio flows via 1) the relationship between portfolio flows and EM FX before and after U.S. financial conditions (U.S. FC) have reached a local peak or trough and 2) what that may imply for EM FX going forward. Portfolio flows in the month before a reversal in U.S. FC have the highest explanatory value for EM FX and then the information content drops off after the turnaround in U.S. FC. Although not as high, looking at portfolio flows over a six-month period before the reversal in U.S. FC also has some predictive power for EM FX. In terms of performance, EM FX sells off before a peak is reached in the tightening of U.S. FC and then rallies thereafter as the market prices an easing of FC. However, the magnitude of the rally is smaller than the selloff - i.e. on average EM FX does not fully recover its losses for at least 6 months after the peak tightening of conditions. Based on our analysis, if U.S. FC experience the same kind of shock that was experienced leading into the peaks in March 2009 & March 2020, then the EM FX selloff has substantially further room to run. However, if the shocks are not as extreme as in 2009/2020, then the current selloff in EM FX may have run its course.”