Dollar Slide Spells Brief Rally for Emerging Market Currencies

(Bloomberg) -- Developing Asian currencies rallied Thursday as investors piled into riskier assets after the Federal Reserve damped bets for a super-sized rate hike.

Thailand's baht surged as much as 1% to lead the gains, as the dollar tumbled after Fed Chair Jerome Powell dismissed the idea of a 75-basis point increase to cool price pressures. Malaysia's ringgit rose 0.5%, while the Indian rupee and Philippine peso each climbed at least 0.3%.

The moves mark a reprieve for regional currencies after expectations of aggressive U.S. rate increases fueled a bout of strength in the greenback. But, some analysts say the rally may soon fade as China's Covid curbs weigh on the global economy and the Fed presses ahead with more policy tightening.

“This is an opportunistic time to reverse the recent weakness in Asian currencies,” said Kiyong Seong, an Asia rates strategist at Societe Generale SA in Hong Kong. “We expect a temporary reversal, lasting a couple of weeks. However, souring risk sentiment as the Fed continues to raise rates will continue to weigh on EM currencies in the longer term.”

The Bloomberg Dollar Spot Index suffered its biggest one-day loss since March 9 on Wednesday after Powell turned out to be less hawkish than some traders had expected. The move propelled the Russian ruble to a gain of 7% while the South African rand strengthened more than 2%.

A jumbo-sized U.S. rate increase may narrow the yield premium that emerging-market currencies enjoy and spur outflows. While some developing central banks have started to withdraw stimulus, most are tightening at a more measured pace than the Fed.

Treasuries Turbulence Far From Over as Skeptics Doubt Fed Path

But, some analysts are more optimistic.

“Should U.S. inflation start to moderate lower through the rest of the year, the Fed will have some ammunition to tone down on their hawkishness,” said Clara Cheong, a Singapore-based global market strategist at JPMorgan Asset Management. “A weaker dollar trajectory going forward can also help enhance international equity returns, specifically the Asia ex Japan region.”

Stocks climbed on Thursday, with the MSCI Emerging Markets Index advancing as much as 1.2% in its biggest jump in a week.

Going ahead, much will depend on how the inflation picture evolves and if the U.S. economy can withstand the weight of further policy tightening without slipping into a recession. U.S. April consumer-price data are due next week.

“We may not have reached peak USD level just yet, and there could still be some weakness for EM currencies amid the risk of recessions in the U.S. and Europe,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. “Real rate differentials will also remain in favor of the U.S. dollar, as the Fed is expected to still be among the most hawkish central banks.”