Underachieving Currencies Key Threat to Fragile EM Rebound

(Bloomberg) -- As stocks and bonds in developing nations recover from the pandemic-fueled sell-off, currencies are trapped in a bout of underperformance.

The MSCI Emerging Markets Currency Index added less than 0.7% in April, while MSCI's equities gauge posted the best monthly rally in four years and local-currency bonds had their biggest decline in yields since 2015. Now, the currency measure is showing technical patterns suggesting a second leg of weakness.

Such a lackluster outlook underscores how unconvinced investors remain about the speed of recovery in risk assets as the Covid-19 fallout underpins demand for the U.S. dollar. Sentiment is caught between the optimism stemming from eased lockdown measures and uncertainty driven by fears of a second wave of infections.

The currency index last week completed a bearish technical pattern called a death cross, with its 100-day moving average falling below its 200-day mean.

Adding to signals for further losses is the so-called flag pattern. The 7.4% decline between January and March forms the “flag pole” and a narrow trading the gauge has been caught in since then forms the “flag.”

Traders interpret this as a breather in a sell-off, a time of consolidation, to be followed by further losses at least as big as the first leg.

The mirror image of this can be seen in the U.S. Dollar Index, where a bullish pennant has formed. The inference here is the opposite: The dollar may be consolidating its earlier gains before starting another rally.

Both stocks and bonds in emerging markets depend on currency stability to sustain their gains. If exchange-rate losses resume, that could well interrupt their nascent recovery.

The currency gauge fell on Monday, on course for the biggest two-day loss since March 19.

©2020 Bloomberg L.P.