Strong Dollar Tests Emerging Market Central Banks

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The rising strength of the U.Sdollar is significantly impacting emerging market currencies, putting them under the strain of a renewed depreciation waveSince October, the MSCI Emerging Market Currency Index has declined by more than 3%, potentially marking the largest quarterly drop since September 2022. This turmoil in exchange rates complicates monetary policy decisions for central banks across the globe, as they navigate the intertwined challenges of inflation and capital outflows, which may hinder fragile economic recoveries.

In Russia, economic conditions have triggered speculation of a notable interest rate hike of 200 basis pointsWhile the Russian central bank has taken measures throughout the year, including multiple rate increases aimed at curbing inflation, the consumer price index (CPI) saw an uptick from 8.5% to 8.9% in November compared to the previous yearThe surge is primarily driven by rising food prices, prompting officials to act decisively.

During an October meeting, the Russian central bank announced the substantial interest hike as it acknowledged that the inflation rate was "far above" earlier summer predictions

The central bank pointed to the sustained growth in domestic demand, which is outpacing the economy’s ability to expand the supply of goods and services, essentially revealing the precarious balance they must strike to stabilize the economy.

The Russian ruble has consequently depreciated sharply, with exchange rates plummeting to 114 rubles per dollar at one point this month—the lowest level since March 2022. This decline followed the imposition of new U.Ssanctions against Russia’s third-largest bank, Gazprombank, aimed at blocking energy-related transactions involving the U.Sfinancial systemIn a bid to combat the ruble's instability, the central bank issued a statement announcing it would cease purchasing foreign exchange for the remainder of the year to mitigate financial market volatility.

With economists predicting another 200 basis point hike at an upcoming policy meeting, the stakes are high

Liam Peach, an economist at Capital Economics, noted that inflation in Russia is likely to rise further in the following months, providing a compelling case for another significant increase in interest ratesRecent data show that companies’ price expectations have reached new heights, positioning the central bank in a challenging fight against inflation where a 200 basis point increase is deemed likelyHowever, there are arguments advocating for an even more aggressive approach.

Shifting to Brazil, the economic landscape also appears troubling, as the Brazilian real has depreciated more than 20% this year, cementing its position as the worst-performing currency among emerging marketsIn November, Brazil reported an inflation rate of 4.87%, exceeding the central bank's target range, which tops out at 4.5%. Earlier this month, Brazil’s central bank opted to hike interest rates by 100 basis points to 12.25%, citing international uncertainties and domestic economic policies as influencing factors

Additional increases are projected in January and March of the coming year.

Despite these measures, the previous three rate cuts this year have not stabilized the real's valueThe latest survey from the Brazilian central bank reflects persistent high inflation expectations for both this year and next, indicating that rates may peak at 14.25% by MarchCompounding the economic woes are proposed public spending cuts by the Brazilian government, which have disappointed investors worried about the nation’s budget deficit and increased market selling pressure.

Finance Minister Fernando Haddad announced a plan to reduce public spending by R$70 billion by 2026, encompassing restrictions on minimum wage growth limits on high salaries for civil servants, and increased taxes on those earning over R$50,000 a monthOn a recent Monday, the real plunged again, hitting an all-time low of 6.10 R$/USD

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Following this dramatic decline, the Brazilian central bank intervened to sell dollars in an attempt to stabilize the marketRecently recovering from surgery, President Lula voiced his criticism of the central bank's rate hikes, arguing that the country’s primary issue is the elevated interest rates rather than inflation being controlled at approximately 4%—deeming irresponsibility lies with those raising rates rather than the federal government itself.

Indonesia’s monetary policy is also under scrutiny, as the Indonesian Rupiah has recently fallen beyond a significant psychological barrier of 16,000 against the dollar after four months of stabilityThe Central Bank of Indonesia responded to this downward pressure by intervening in the foreign exchange market, utilizing multiple strategies, including spot foreign exchange transactions and purchasing government bonds on the secondary market

Edi Susianto, head of the Bank of Indonesia’s monetary management department, affirmed their commitment to bolstering market confidence in the rupiah.

Foreign capital continues to flow out of Indonesia’s financial markets, with recent trading data revealing a net outflow of 51.3 trillion rupiah (around CNY 2.4 billion) between December 2-5. Winson Phoon, head of fixed income research at Malayan Banking in Singapore, noted that stabilizing the rupiah takes precedence in the central bank's policy considerationsAlthough the current spot price of 16,000 is likely not the floor, it remains sensitive to U.SFederal Reserve rate revaluation risks.

Several institutions predict that the Indonesian central bank may pause rate cuts in the upcoming week, with Barclays economist Brian Tan expressing concerns that the weakness of the rupiah heightens the risk of the bank being compelled to halt its easing cycle

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