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Commodity prices typically move in tandem with emerging market currency returns. Many emerging markets are major exporters of metals, oil and gas, and agricultural products, which means that strong demand for commodities boosts these countries’ export prices and currencies. But this year the relationship between commodity prices and emerging market currencies has come under pressure.

The gap that has emerged between commodity prices and emerging market currency returns might previously have been explained by a stronger dollar or higher inflation in developing countries. But the dollar has been broadly flat or weak against other currencies this year, while higher inflation in emerging markets has been matched with similar price increases in the US. 

A lack of carry - or the benefit investors get from borrowing in one currency and investing in another with a higher yield - could be another reason for the divergence, particularly after many developing economies carried out emergency interest rate cuts in 2020. But this argument no longer holds after countries such as Brazil and Turkey raised interest rates substantially this year.

Political and economic uncertainty puts pressure on emerging market currencies 

The weakness in emerging market currency returns is more likely attributable to political and economic turmoil in several developing economies. Turkey has struggled with a crisis at its central bank and a lack of tourism revenue, while Russia faced international condemnation after arresting opposition leader Alexei Navalny. Peru, meanwhile, has been plunged into uncertainty after a contested and narrow presidential election result, and Brazil and Colombia are both grappling with fiscal policy problems. All this has soured investor appetite for emerging market currencies. 

We are cautiously optimistic that emerging market currency returns will start to catch up with commodity prices. In the long run, strong demand for commodities should improve trade balances and help prevent currency depreciation. But political and economic difficulties are unlikely to vanish overnight. That means the currencies with higher carry - currently the Egyptian pound, Ghanaian cedi, and Turkish lira - could act as a useful cushion against any further bumps in the road as uncertainty starts to ease. 

Marton Huebler

Marton Huebler

Co-Portfolio Manager - Fixed Income