Thoughts on Some EM FX Pegs

Lightbulbs pendulum passing ideas

The combination of falling commodity prices and rising US interest rates has focused market attention on some EM currency pegs.  Below is a quick rundown of recent developments.

Hong Kong: The HKMA today hiked its base rate 25 bp, following the Fed’s move. There was speculation that it would not hike given the strong HKD (trading at the strong end of the 7.75-7.85 band) despite abundant liquidity in its financial system. We see no change to the strict HKD peg for the foreseeable future.

Vietnam: The central bank today cut the USD deposit rate cap to 0% in order to discourage dollar hoarding. The dong fell to the weak end of its trading band this week, which is +/- 3 percentage points around the official reference rate of 21890. This rate has been kept steady since the third devaluation this year back in August. This is not a strict peg, and so further adjustments appear likely in 2016.

Czech Republic: The central bank yesterday reaffirmed that the current floor for EUR/CZK “around” 27 would likely be maintained until end-2016. The bank noted that it could end the floor even if the ECB is continuing its QE program, but pledged to intervene to prevent any excessive movements when the floor is eliminated. With deflation risks persisting, we think there is a risk that the floor will be maintained into 2017.

Egypt: There has been growing speculation that new central bank Governor Amer would loosen capital controls and allow greater movement in the pound. Like Argentina, capital controls did not alleviate the supply-demand imbalance for dollars and foreign reserves have continued to bleed. This is not a strict peg, and so we think the pound will have to be weakened.

GCC: Bahrain, Kuwait, Saudi Arabia, and UAE all hiked rates yesterday and today by 25 bp to match the Fed and maintain their respective strict pegs against the USD.

Nigeria: There has been growing speculation that the naira will be devalued. Here too, capital controls have not alleviated the supply-demand imbalance for dollars and foreign reserves have continued to bleed. The black market rate of 265 is well below the official rate near 199. This is not a strict peg, and so we think the naira will have to be weakened.

Argentina: Yesterday the peso was moved to a free float and capital controls were eliminated. The crawling peg used by the previous administration was simply unsustainable, as foreign reserves were dwindling. President Macri honored his campaign promise to free up the peso, while the central bank said it would intervene as needed to prevent an overshoot. We see further peso weakness ahead under the float.

Venezuela: The recent opposition victory in congressional elections is a good sign that perhaps the nation will follow Argentina in rejecting unorthodox policies. Unfortunately, President Maduro’s 6-year term doesn’t end until 2019 (assuming that the opposition doesn’t manage to somehow end his term early). There has been no FX adjustment since 2013, and so we could see a devaluation in 2016. True FX reform seems unlikely under Maduro.