Diminishing prospects of Fed rate hike bodes well for BRICS currencies

Brett Chatz

The culprits are many; suffice it to say that the divide between developed economies and emerging market economies remains. Leading from the front is structural weakness in China. Recent economic data released from China indicates that imports in September 2015 declined by 20.4% year-on-year. This data exceeded forecasts, and confirmed global economic sentiment vis-a-vis the China slowdown.

As the world's second largest economy and the greatest consumer of energy, metals and other mining resources, what happens in China impacts heavily on the rest of the world. This is particularly true of EM countries. Since EM nations are primarily involved in energy, mining and agriculture, a large chunk of their GDP is dependent on their export potential to countries like China.

Equities meltdown

With the equities meltdown that took place in August and September, we have seen trillions of dollars erased from global bourses in merely a few weeks. This has had a profound effect on the economic fortunes of EM countries, and their currencies.

For example, a global slowdown led by China results in significantly weaker demand for the manufacturing output of countries like Zambia, the Democratic Republic of Congo, South Africa, Venezuela, Brazil etc. With declining demand comes declining revenues, layoffs, the shuttering of divisions of multinational companies and so forth. Naturally, it is clear how this impacts on the demand for and strength of the currencies of these countries.

Slack demand in China is unlikely to be picked up by developed markets like the US, Canada or even the European Union. The fact of the matter is that China alone accounts for substantial export revenues for EM economies. Unless a turnaround in the fortunes of the Chinese economy takes place, we are likely to see a preponderance of weak commodity prices, weak currency cross-exchange rates for EM economies, and the continued closure of copper mines, platinum mines, silver mines etc.

Closing of mines

Already Glencore PLC has taken the initiative by shuttering mines in the DRC and Zambia, and a major platinum mine was recently closed in South Africa (Eland Mine), leading to the loss of 970 jobs. These types of actions have ripple effects on the industry, and while the long-term prospect is perhaps positive, the short-term reality is not. Mining companies are seeking to reduce the supply of metals and precious metals and in so doing raise the equilibrium point between supply and demand to a higher price level.

Yet, despite all the negative factors impacting on EM currencies we are seeing a mini-rally taking place. This boggles the mind, since the structural weakness in China has not been addressed and global sentiment remains bearish. Japan is staring down the barrel of a recession, the Eurozone is facing multiple challenges of its own with persistently low inflation, high unemployment and a massive monetary expansion programme.

The US has its own set of challenges including slowing retail sales and poorly performing jobs numbers. Against this backdrop, it seems disingenuous to suggest that EM currencies should be undergoing a turnaround - but that's precisely what is going on. It all boils down to market anxiety and speculative sentiment.

US export potential

The Fed rate hike that was expected to pass in September did not come about. Janet Yellen, along with policymakers at the FOMC, decided against hiking interest rates for fear that a rate hike would endanger the global economy and the US economy.

A stronger dollar makes commodities prices more expensive for foreign buyers, since most commodities are dollar-denominated. This would hurt US export potential since the dollar is currently highly bullish and resistant to many of the pressures that have so far spilled over from China. When the dollar is strong, the demand for precious metals tends to sour.

The 2% inflation target set by the Fed has not yet been achieved and the latest figures released last week indicate that we are still below target in this regard. This weakens the demand for the dollar and strengthens EM currencies.

Recall that speculators thrive on uncertainty and the first victims are EM currencies. Additionally, the likelihood of a Fed rate hike in 2015 is growing slimmer (now at 27%) and this bodes well for EM currencies like the ZAR which has shown remarkable resolve in recent days.