Over the past month, the COVID-19 virus has continued to affect many emerging and frontier markets. The worst hit region appears to be LATAM, headed by Brazil but India, South Africa, and Russia have also struggled to contain the virus. The bad news is the virus is taking its toll on the economies; last week, the IMF significantly downgraded the growth outlook for 2020; especially for India (-6.5pp), Mexico (-3.9pp) and Brazil (-3.8pp).
The good news is the growth rate of new cases is coming down in most countries with the exception of India and South Africa. However, the test capacity in EM is weaker than in developed countries and this adds to less visibility on the situation).
Differences in the prevalence of COVID-19 have contributed to relative performance of EM FX over the past month (chart 2). LATAM currencies such as BRL, MXN, CLP and ARG have lost most ground to the USD as policy easing and/or worsening of economic fundamentals have been priced in. Meanwhile, in the other end of the spectre we find currencies of countries with best control over the virus, such as KRW, THB, CZK and to some extent PLN and RUB.
As the spread of the virus is starting to slow down and economic recoveries get underway in most countries, we think global factors will resume as key drivers in EM FX and the USD is set to be pivotal. In our base-case of a weakening USD over the coming months as Fed keeps the printing press open and the global and US recovery strengthens further, we are cautiously optimistic on EM FX. A key risk is the rapid spreading of the virus in many southern and western US states, which could derail the nascent US economic recovery and send the USD higher. In such downside risk scenario, EM FX will be under pressure.
USD/RUB is likely to have overshot its fair value and we remain optimistic on RUB; target 73.26 versus EUR in 12M.
USD/TRY is bid as TRY is on the verge of yet another FX crisis and FX interventions are very likely happening. We need broad USD declines to avoid further depreciation of TRY near-term, but this may just happen.
USD/ZAR continues to drift lower, as investors are being pushed to hunt for yield. Recently, appetite for ZAR has stalled but we remain optimistic for ZAR strength to resume in coming months.
USD/CNY should move lower with the broad USD weakness. A key upward risk is China-US tensions flaring up over HK.
USD/INR is lagging versus EM peers, maybe due to continued COVID-19 issues. We target 72.00 on 12M.
Excerpt from Danske Monthly EM Report
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