A lot of people were surprised by the vehemence of the sell-off in emerging market currencies in September, but we have always argued that, when conditions deteriorate very sharply, there will be no ‘decoupling’ between emerging and developed markets. Emerging market currencies were outperforming strongly through the end of August, but as the global economic crisis continued to unfold, these currencies also started to crumble.

The near-term direction of markets is entirely at the mercy of the global sentiment and, in particular, the adequacy of the policy response to the European sovereign debt crisis. In addition, as we also know from past experience, emerging market currencies can ‘overshoot’. However, we are encouraged to see that after a very rapid sell-off, emerging market central banks are starting to take steps to support their currencies. For example, in a reversal of a 26-month old policy, the Brazilian authorities intervened in late September, selling $2.75 billion of currency swaps in a move to support the real. 

Meanwhile, the Indonesian authorities sought to bolster the rupiah by purchasing long-dated bonds. Elsewhere, Russia announced that it had no plans to revise (higher) the rouble trading band, while indications are that the Mexican monetary authorities will intervene ‘verbally’ in support of its currency.

While the deceleration of global economic activity is clearly not positive for emerging market currencies, the more compelling currency valuations, the change in stance by local monetary authorities, and the fact that the ‘growth differential’ story of emerging markets is still intact, reinforce our argument that, for investors seeking exposure to riskier assets, emerging market local currency-denominated bonds remain an attractive proposition.

Headquartered in Boston, USA, Standish is a specialist active fixed income manager investing in global fixed income markets and across the full credit spectrum.