FX Viewpoint | EM FX: US-China policy divergence to gain traction | Article – HSBC VisionGo
- EM currencies have faced more hurdles lately
- The USD’s resilience has posed a challenge alongside signs of peaking global growth
- US-China monetary policy divergence suggests a higher USD-RMB, thereby guiding other USD-EM pairs higher
Many EM currencies have struggled, amid the USD’s resilience
Many emerging markets (EM) currencies struggled in July, as the broad USD strengthened on risk aversion. The rapid global spread of the Delta variant fueled concerns about global growth. More recently, high volatility in Chinese equities (amid regulatory changes for some industries) and US-China political noise also weighed on risk sentiment.
There are signs of peaking global growth
China has been leading the global recovery from the COVID-19 pandemic, but its sequential (QoQ) growth (that has historically been a good leading indicator for the rest of the world) has probably peaked in 2Q. Our China Activity Surprise Index has also declined in the past months (Chart 1). We believe some moderation in global growth would likely herald the end of the USD’s cyclical decline and make it harder for EM currencies to appreciate, comfortably. Moreover, it would only emphasise the importance of domestic policy framework in differentiating which EM currencies should outperform the others.
The Fed is transitioning towards tapering, while the PBOC cut its RRR broadly for most banks
In our view, the most important policy divergence is between the Federal Reserve (Fed) and the People’s Bank of China (PBOC). Fed Chair Jerome Powell said that the 27-28 July meeting was the first time that the Federal Open Market Committee (FOMC) began a “deep dive” on the issues of time and pace and composition of tapering. Our economists expect a formal tapering announcement in December. In contrast, the PBOC has taken a different path, as it announced on 9 July that it would implement a broad-based reserve requirement ratio (RRR) cut of 0.5%, effective 15 July 2021, aiming to support growth. This will likely reflect in a narrower yield advantage of the RMB, supporting our thinking that USD-CNY should move higher in the coming months.
A gradually higher USD-RMB will probably guide most USD-EM pairs higher, in our view
However, the absolute yield advantage of the RMB is still high at the moment and hence the currency’s weakness should be gradual (Chart 2), which in turn means EM currencies can adjust in an orderly manner. In the bigger picture, it is another reminder that the USD’s outlook is not as benign as it used to be.
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