Latest / The Emerging Markets Podcast with Fexingo: Developing Economies, Growth, and Investment / Why Emerging Market Currencies Are Splitting Into Two Camps
Transcript
- Lucas: So we talk a lot about how emerging market stocks are splitting into winners and losers, but there's an even sharper divide happening right now in currencies, and it's one that's easy to miss if you're just watching the headlines. Luna: Yeah, because the dollar's been softening, so you'd think emerging market currencies would all get a reprieve. But that's not what's happening. Lucas: Exactly. The trade-weighted dollar index has eased to 118.9, down slightly from 119.18 a few days ago. The yuan's been stable around 6.74 per dollar. But look at the lira or the peso — those are sliding. And some of the usual suspects, like the Mexican peso, are actually holding up quite well. Luna: So it's not just a 'risk on, risk off' story anymore. You've got to look at each country's fundamentals. Lucas: Right. And that's the angle I want to drill into today: why are emerging market currencies splitting into two camps — the ones with central bank credibility and solid external balances, and the ones that are still fighting inflation or political instability. And what does that mean for investors who are trying to pick the right exposure? Luna: Before we get into the weeds, I want to flag something. If you're getting value from these conversations, a couple of dollars a month genuinely keeps them going — buy me a coffee dot com slash fexingo. We keep the show ad-free and independent, and that's only possible because of listeners like you. Lucas: Yeah, it really does make a difference. And the fact that we can get into the specifics, like today's currency question, without worrying about sponsors — that's worth protecting. Luna: Totally. So back to the split — what's driving it? Lucas: Let's start with the lira. Turkey's central bank has been raising rates, but the credibility gap is huge. Political pressure on the central bank persists, and inflation is still running hot. So even with a supportive global backdrop, the lira keeps drifting lower. Luna: Meanwhile, the Mexican peso has been a different story. It's been one of the best-performing EM currencies this year, largely because of nearshoring and solid fiscal discipline. Lucas: Right. Mexico is attracting manufacturing investments that used to go to China, and that's creating real demand for pesos. Banxico has also been pretty hawkish, which helps. So you've got a currency that's supported by both fundamentals and capital flows. Luna: And then there's Brazil — the real has been firm, but not as strong as the peso. What's the difference there? Lucas: Brazil's a bit more mixed. Commodity exports are doing well, but the fiscal situation is looser, and there's more political noise. So the real is holding up, but it's not the standout that Mexico is. Luna: So is this split just about central bank credibility, or are there other factors? Lucas: It's a combination. Look at India. The rupee has been surprisingly stable despite a large trade deficit. That's because of strong capital inflows — both portfolio investment and FDI, especially in tech and manufacturing. Plus the RBI has been actively managing the currency. Luna: And then you have countries like Indonesia or South Africa, where the currencies are more commodity-driven. They're vulnerable to swings in oil and metals prices. Lucas: Exactly. So you've got a few buckets: the 'credible central bank' crowd — Mexico, India, maybe Brazil — and the 'still dealing with structural issues' group — Turkey, Argentina, and to some extent, South Africa. Luna: And for investors, that means you can't just buy an emerging market currency ETF and call it diversified. You're taking on very different risks depending on which currency you're exposed to. Lucas: Right. And this is timely because the EEM ETF is down 1.5% over the past five days, and the Korea ETF — EWY — is down 2.7%. So the equity side is already pricing in some of this divergence. But currencies can add another layer of volatility or stability, depending on where you're positioned. Luna: So if I'm an investor, how do I think about currency risk within my EM allocation? Lucas: First, don't ignore it. A strong local currency can boost your returns when you convert back to dollars. But a weak one can wipe out equity gains. Second, look at the carry trade. Right now, the Mexican peso offers a decent yield with relative stability, while the Turkish lira offers a high yield but with massive depreciation risk. Luna: So it's not just about yield — it's about yield adjusted for currency risk. Lucas: Exactly. And that's where central bank credibility becomes so important. A country with a credible central bank can keep inflation anchored, which supports the currency. A country that's seen as politically interfering with its central bank will see its currency risk premium rise, no matter what the nominal yield is. Luna: How much of this is actually reflected in the current market? Are investors already pricing in this divergence? Lucas: Some of it, yes. The fact that the peso has been outperforming the lira is evidence of that. But there's also a lot of complacency — the dollar's been softening, and some investors are treating all EM currencies as a single trade. That's dangerous. Luna: And what about the yuan? It's been remarkably stable around 6.74 per dollar. Is that realistic, or is it being managed? Lucas: It's definitely managed. The PBoC has been using the daily fixing to keep the yuan stable, especially ahead of any potential trade negotiations. But with China's export numbers still strong — exports of goods and services are up to $3.75 trillion as of April — they have room to let it move a bit if needed. Luna: So a stable yuan is kind of a policy choice, not just a market outcome. Lucas: Right. And that's another layer of the divergence — some currencies are allowed to float, others are managed. You have to know which one you're dealing with. Luna: So what's the takeaway for listeners who want to position their portfolio for this? Lucas: I'd say don't just buy a broad EM fund and assume you're diversified. Look at the currency composition. If you want stability, lean toward countries with credible central banks and strong external positions — Mexico, India, maybe Brazil. If you're chasing yield, just be aware you're taking on more currency risk — and that risk can be bigger than the yield itself. Luna: And the current environment of a softening dollar gives you a chance to rebalance before the next leg of the dollar's move. Lucas: Exactly. The dollar isn't going to stay weak forever. When it turns, the currencies with weak fundamentals will get hit the hardest. So now is the time to make sure you're not overexposed to those. Luna: Makes sense. Any specific moves you're watching in the next few months? Lucas: Keep an eye on the Turkish central bank — if they manage to maintain independence, the lira could stabilize. And watch the Mexican peso around the next Banxico meeting. If they signal more rate hikes, the peso could strengthen further. But also watch for any surprises in the US elections that could change the dollar's path. Luna: So it's not just emerging markets — it's a global story. Lucas: It always is. Emerging markets don't exist in a vacuum. But within that, the divergence is becoming sharper and sharper. And for investors, that's actually an opportunity — if you can identify which camp a currency falls into, you can make better decisions. Luna: Well, this has been a great framework. Thanks, Lucas. Lucas: Thanks, Luna. And to our listeners — if you enjoyed this, we'd love to hear from you. And if you can, consider supporting us at buy me a coffee dot com slash fexingo. It really does make a difference.