If we use the JP Morgan Emerging Market FX index as a proxy, then we’ve seen a near relentless fall in EM FX 2013-15. During this time we’ve seen Fed tightening expectations march right up the hill (to over 100bp of tightening priced on the Euro-dollar strip as shown) to around 20bp as seen currently. But for the most part of 2015, EM FX was oblivious to this flattening out of rate expectations, partly because the Fed, whilst preparing markets for a near-term tightening, also played down the scope of the impending rate hike cycle.
What has provided support this year is both the fact that easing has been postponed and it has not led to a view that this will lead to more tightening later, hence the continued flatness of the Euro-dollar strip. This has been a factor in offering support to the Brazilian real, which last year was one of the worst performing currencies amongst its EM peers. Argentina has not been far behind. Both have seen political change in the past 6 months, which has provided some hope.
For Argentina, the turn-around has been pretty dramatic, at least from the early March lows. Indeed, last month the central bank had to quell overseas demand owing to currency strength. It’s still some way before we return to the levels prevailing in the wake of the December devaluation. The bottom line is that for both Argentina and Brazil, the better Fed backdrop should continue to offer support, but for Brazil this is likely to prove far more transitory than for Argentina. There is only so much time the real can continue to defy gravity, especially with the economy seen falling another 3.5%-4.0% this year.