Emerging market (EM) exchange rates have appreciated significantly since the U.S. elections, according to recent data from Oxford Economics.
Tariffs were expected to exert pressure on EM FX, but trade has proven resilient to higher tariffs and markets have often traded a weaker dollar in response to unpredictable U.S. policies. The strength of EM FX is a sign of resilience but could be a vulnerability if current accounts worsen due to real appreciation.
Oxford Economics’ assessment is that widening EM external imbalances are unlikely this year.
“Real exchange rates have appreciated in many countries since October 2024, though in several cases by less than 5%. In Asia, we've seen significant real depreciation in India and Indonesia, and minor exchange rate moves elsewhere. Risks from excessive real appreciation are minimal in the region,” the study says.
Key takeaways:
· In Latin America and Hungary, appreciation is significant enough to warrant a closer look at its potential impact on the current account.
· In Mexico, Peru, and Hungary, appreciation since October 2024 has driven their real exchange rates (REERs) to strong levels by historic standards. In Peru, high copper prices largely justify appreciation. In Colombia, its REER remains at average levels despite substantial appreciation.
· In Poland, the strong REER is backed up by improvements in productivity and largely reflects real convergence. Polish exports are diversified in terms of products and exporting markets. The industrial base is broad and industrial production has been in a league of its own in the EU.
· An estimation of the impact of recent REER changes on the current account adds context to the simple analysis of REER levels.
· According to these stylized calculations, several current accounts could markedly worsen as the effects of appreciation theoretically materialize over the next two years.
· Mexico illustrates the risks of taking the results of current account-based valuation models at face value. The REER has appreciated 16% since 2019, but the current account has improved.
· U.S. tariffs should be negative for EM FX as they have a negative impact on EM exports. It's unclear if EM FX will respond in a clear direction to the Supreme Court's ruling and the blanket tariff response by the U.S. administration. A few major EMs like Brazil will likely be subject to lower tariff rates but investors may end up simply trading a weaker dollar versus most currencies given policy unpredictability.
