Dollar rebound could choke emerging markets

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Dollar rebound could choke emerging markets

A rebound in the world's reserve currency could choke the current rally of its peers in emerging markets.

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Brendan McKenna, a Wells Fargo Securities strategist who believes that investors will flock to the U.S. dollar just as the risks in developing economies come into focus, is the view of Brendan McKenna. The firm was among the most accurate forecasters of major currencies in the fourth quarter and No. He said that the dynamics that have supported foreign currency, especially emerging market currencies, are unlikely to persist. As the focus shifts back to country-specific fundamentals, we believe that investors will divert capital back to U.S. dollar-denominated assets, which should be supportive of the dollar over time. It is a stark outlook compared to those from Societete Generale and Morgan Stanley, which have brightened their stances on some emerging assets in recent days. It came after the best week for a key MSCI Inc. gauge of developing currencies since early September.

The index fell on Tuesday, with 21 of 24 emerging currencies down. The Turkish lira and the Hungarian forint were among the biggest decliners. The dollar was headed for its biggest gain since the first trading day of the year.

It's likely that tighter Federal Reserve policy and higher bond yields will take the steam out of an early advance in developing currencies, especially in nations where local political developments could be negative, according to McKenna. The rally will be the most intense against emerging currencies as the dollar may gain against Group-of- 10 peers this year, he said.

He pointed out that there was the possibility of upcoming elections in Colombia and Brazil, as well as the fallout of sharp political turns in Peru and Chile last year. Political risk in South Africa and geopolitical tensions for Russia may keep the rand and ruble on the back foot, while unorthodox policy in Turkey may continue to weigh on the lira. The renminbi could be put under pressure on emerging Asian currency, as a result of the diverging Chinese and U.S. monetary policy, according to McKenna.

BNP Paribas strategists, including Burak Baskurt, are expecting emerging currencies to weaken against the dollar, as the Fed begins quantitative tightening, though they said much of the impact took place last year as investors started pricing in Fed tightening.

Morgan Stanley strategists led by James Lord removed their long-standing bearish view on emerging currencies earlier in the day. They now hold a neutral position, recommending traders focus on relative value within developing-economy exchange rates.

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