• Emerging market currencies have been under pressure recently, partially reversing strong gains seen last year.
• BAML warns that further losses could be on the way ahead of the US mid-term elections.
• It nominates the Korean won, South African rand and Singapore dollar as being vulnerable to downside pressure.

After ripping higher in 2017, underpinned by an improvement in the global economy and broad-based US dollar weakness, emerging market currencies have been under pressure in recent months, including earlier this week.

Think the Turkish lira, Indian rupee, Argentina peso and, more recently, the Brazilian real. There have been others, albeit to differing degrees.

A reversal in the US dollar earlier this year, along with ever-tightening monetary policy settings from major central banks, has taken its toll.

Well, we haven’t seen anything yet.

According to Bank of America Merrill Lynch’s (BAML) Global Rates and Currencies Research team, the reversal in the US dollar against EM currencies this year has got a lot further to go yet.

It says a US dollar “bulldozer” is coming, pointing to the chart below.

“[The] USD rally is about to take its toll on emerging market currencies, according to our weekly Moving Average Aggregator (MAA),” says Vadim Iaralov, FX Strategist at BAML.

“Over the last two months EM FX longs have been under pressure with USD recovering the most ground since the 2011 EM rout.

“Our indicator suggests the present sell-off has been selective and localised so far — [limited] to USD/INR and UDS/TRY — given USD breadth remains slightly negative but we cannot rule out stress to other EM currencies if things go south.

“In addition, JPY is already peaking like in previous EM FX selloffs.”

Iaralov says past reversal episodes have taken four to six months to unwind trough to peak, suggesting the risk is for the US dollar to rally into the US midterm elections in November.

In particular, Iaralov nominates the Korean won, South African rand and Singapore dollar as being vulnerable to downside pressure should EM weakness continue.

Given increased volatility in EM of late, it should be an interesting period ahead, particularly if the ECB announces an end date for its asset purchase program next week.

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