Euro Becomes Key Marker of Emerging-Market Currency Strength

(Bloomberg) -- The euro's strength since the middle of May is giving legs to the rally in emerging-market currencies.

The single currency has gained against the dollar on 12 of the past 15 trading days, helped by the European Union's proposal to launch a 750-billion-euro ($842 billion) crisis fund. That vigor has halted the U.S. dollar's meandering, sending it on a weaker path and giving developing-nation currencies the green light to extend their rally.

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“Euro appreciation against the dollar is a widely followed symbol of generalized dollar weakness, which encourages investors to invest in assets that are denominated in other currencies,” said Kasper Bartholdy, a London-based strategist at Credit Suisse Group AG.

The euro and emerging-market currencies are now showing the strongest correlation since late 2016, a period leading up to the previous U.S. presidential election. As late as March, their swings were diverging by the most since 2001.

The euro's correlation with the yuan stands out in particular. Investors follow their relationship given China's currency has emerged as an indicator of global risk sentiment in recent years. The two currencies are now tracking each other to the greatest degree in 17 months.

Any gain for the euro against the dollar ends up making developing nations more competitive in global trade against the euro zone. Put another way, it enables emerging-market currencies to appreciate against the dollar while maintaining some of their previous competitiveness.

However, the positive relationship works only when other risk-on factors are in place, Kasper said. This time, the euro's gains have coincided with rallying U.S. equities, tightening U.S. corporate-bond spreads and rising commodity prices.

Credit Suisse expects the combination of these factors to continue for some time. That will support emerging-market currencies, even if investors are on guard for stretched valuations.