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BENGALURU/JOHANNESBURG - Battered emerging market currencies will only pare some of their recent steep losses over the coming year, according to analysts polled by Reuters who said a sell-off was likely in the next three months with rising U.S. yields posing a big risk.
Having strengthened over 3% in 2020, an index of emerging market currencies erased nearly half of those gains in the last three months as reflation bets spurred by massive U.S. fiscal stimulus drove the dollar index to a four-month high.
A majority of FX strategists in the March 26-31 Reuters poll said the dollar's recent strength would be short-lived and stuck to their previous view that the greenback would weaken against emerging market currencies.
Still, most won't recoup heavy losses made so far this year.
"Amid the reflationary expectations pulsing through markets the outlook has become even more complicated. The single biggest risk is a destabilising rise in U.S. Treasury yields that impairs equity/credit markets, leading to incremental capital flight from EM markets and pressure on currencies," said Jason Daw, head of emerging markets strategy at Societe Generale.
"There will be tactical long EM FX opportunities during periods of oversold conditions, but over a medium-term horizon, a neutral-to-bearish stance is warranted. At best, currencies will tread water and at worst resume their long-term depreciation trend."
When asked about the likelihood of a sell-off in emerging market currencies in the next three months, nearly 60% of 53 FX strategists who answered an additional question said likely, including six who said very likely.
That lines up with the findings of a separate Reuters poll of fixed income strategists who said another global bond market sell-off was likely in the next three months.
For a graphic on Reuters Poll: Emerging market currencies outlook:
Emerging market central banks have come under increasing pressure from global rising yields, weakening currencies and raising inflation strains. Policymakers in Russia delivered a surprise rate increase last month while in Brazil and Turkey they hiked by more than expected.
But that was not expected to give any significant boost to currencies in less developed countries.
"The surprise rate hikes from Brazil, Russia and Turkey don't change the picture that most EM central banks will stay dovish, providing less support for EMFX," said James Lord, global head of EMFX at Morgan Stanley.
Turkey's lira has been one of the worst performing emerging market currencies this year, behind only the Argentine peso and Brazilian real, as concerns about Turkey's falling forex reserves and high inflation levels erased gains from a series of interest-rate hikes since November.