EM FX: Between phase 3 “bargaining” and phase 4 “depression” – HSBC

Using a model from Elizabeth Kiibler-Ross, analysts at HSBC consider emerging market currencies are following five phases to recovery. They see markets now nearing Phase 4, which is the riskiest for EM FX. They consider a move to Phase 5 will eventually happen, when the recovery of EM currencies begins, but idiosyncratic factors will then have more influence on the recovery individual currencies.

Key Quotes: 

“We see the Federal Reserve's (Fed) emergency rate cut on 3 March as ushering in Phase 3 "Bargaining". Globally, central banks are lowering their interest rates at the fastest pace since 2008. Other measures have also been deployed.”

“Despite the broad range of policies being rolled out, EM FX has not yet stabilised. This suggest to us that we are nearing Phase 4. Here, markets consider the idea that policymakers are running out of options, yet more radical measures and outcomes could emerge (...) This is a risky period for EM FX.”

“We will shift into Phase 5 "Acceptance", where a sense of calm is slowly restored. This is not the easiest to identify in terms of timing. We adopt the view that economic conditions will be poor, globally, in 2Q20, but then the healing process can hopefully begin. This is also the point, where we expect EM currencies to show some degree of recovery. Obviously this can only happen, if the global health emergency abates in the coming months. Yet, our caution is that events could suddenly change again — for the better or worse.”

“We are still assuming that many USD-EM exchange rates have overshot recently, but they will stay quite elevated over the near term, while risk aversion persists, before partially retracing in the second half of the year. The retracement is unlikely to be complete by the end of 2020 for some currencies, particularly those that are more affected by a prolonged downturn in the services sectors (e.g. the SGD), or a protracted terms of trade shock (e.g. the MYR), or persistent risk aversion (e.g. the INR).”