Throughout the COVID-19 pandemic of 2020, emerging market (EM) currencies faced a collection of unprecedented challenges. As a result, many EM currencies experienced a swift devaluation due to falling commodity prices and a large-scale migration to financial safe-havens. Although renowned for their volatility, these currencies encountered extreme forex turbulence as COVID-19 brought the global economy to a standstill.
What Is An Emerging Market Currency?
An EM currency is one that is rooted in a "developing" or "emerging" economy. The performance of emerging economies is typically dependent upon the exportation of commodities, multinational manufacturing and regional trade affiliations. In the event that these sectors experience a downturn, EM currencies frequently exhibit weakness vs the global majors.
Below are the forex's leading emerging market currencies:
- South African rand (ZAR)
- South Korean won (KRW)
- Mexican peso (MXN)
- Brazilian real (BRL)
- Russian ruble (RUB)
- Chinese yuan renminbi (CNY, RMB)
EM currencies are known for their volatility and growth potential. These two attributes are particularly attractive to forex traders seeking extraordinary returns. However, in addition to the potential for large gains, added risk is a constant part of their market dynamic. Political instability, commodity pricing volatility, social unrest and military conflict all contribute to an enhanced risk profile. The COVID-19 pandemic of 2020 was no exception as crashing commodity prices and global lockdowns fostered bearish sentiment toward EM currencies.
When studying EM currencies, it's important to make special note of the Chinese yuan renminbi (CNY, RMB). The CNY is held in high regard by the International Monetary Fund (IMF), acting as the fifth-largest holding in the IMF's foreign exchange reserves. It is the single-largest EM currency in the basket, estimated to be worth US$217.67 billion (Q4, 2019). Although China's status as a developing nation with the World Trade Organisation (WTO) is controversial, the CNY technically remains an emerging market currency.
How Does COVID-19 Impact EM Currencies?
COVID-19 placed significant pressure on the foreign exchange rates of EM currencies. Widespread lockdowns, travel bans, and quarantines prompted a severe world-wide economic contraction. According to the World Bank Group's (WBG) June 2020 Global Economic Prospects Report, international GDP was to fall by 5.2% for 2020. Developing regions were hit especially hard, with GDP 2020 contracting drastically in Sub-Saharan Africa (-2.8%), North Africa (-4.2%) and Latin America (-7.2%).
A swift shutdown of commerce, turbulence in the commodity markets and a rush to safe-havens destablised the exchange rates of EM currencies. Even though the growth potential of developing nations was thought to foster rapid economic and financial recoveries, short-term bearish pressure dominated forex valuations. Below is a look at how the leading EM currencies performed against the U.S. dollar during the initial stages of the COVID-19 pandemic (1 January 2020 to 1 June 2020):
***For ease of comparison, EM currencies are listed as the base currency
- ZAR/USD: The South African rand lost 20.2% of its marketshare against the USD.
- KRW/USD: Exchange rates for the South Korean won fell by 6.4% versus the USD.
- MXN/USD: Values of the Mexican peso to the USD plunged 14.6%.
- BRL/USD: The Brazilian real crashed a staggering 24.7% vs the USD.
- RUB/USD: Rates of the Russian ruble to the USD posted a loss of 11.8%.
- CNY/USD: Compared to the other major EM currencies, the Chinese yuan held its value well vs the USD, losing only 2.4%.
Note: Past performance is not an indicator of future results.
So, why the extreme weakness against the world's reserve currency, the USD? The answer to that question is largely two-fold―slumping commodity prices and an investor mass exodus to safe-haven assets.
COVID-19 Rush To Safe-Havens
During the onslaught of COVID-19, traders and investors actively sought shelter from the pending financial storm. Beginning in late-February and extending through March 2020, steep sell-offs in the global equities markets became commonplace. Crashes in the Dow Jones Industrial Average (DJIA) and the Standard & Poor's 500 (S&P 500) occurred frequently, with the latter hitting circuit breakers repeatedly during March. The intense selling was the product of a full-blown market panic and an onus being placed upon security.
Due to their reputation for instability, EM currencies ended up far down any list of desirable assets. Forex participants heavily favoured the USD as companies, banks and governments stockpiled USDs as preferred safe-haven assets. During the height of spring 2020's COVID-19 panic, the USD Index reached levels not seen since the early 2000s. From 9 March 2020 to 19 March 2020, the USD Index rallied from 95.00 to 102.70, a ten-day gain of 8.1%.
In addition to the USD's robust performance, traditional safe-haven gold showed vitality against EM currencies. Although bullion struggled to maintain its value vs the USD, it gained tremendous marketshare during March 2020 against several leading EM currencies:
- XAU/ZAR: Gold rallied by 13.38% versus the South African rand.
- XAU/RUB: Bullion posted a one-month 17.78% gain against the Russian ruble.
- XAU/CNY: Similar to the USD, the Chinese yuan held its value relatively well in comparison to gold. For the month of March, the XAU/CNY gained a modest 1.44%.
As COVID-19 economic uncertainty grew, the value of EM currencies suffered in comparison to gold and the USD. Although not much of a surprise, the lack of demand prompted substantial market corrections.
Commodity Market Tumult
For a vast majority of developing nations, the production and exportation of commodities is an economic staple. Accordingly, commodity pricing can be a determining factor in growth, output and overall performance. Whether the raw material stems from the agriculture, metal or energy sector, an unexpected downturn in asset value often places extreme pressure on the domestic economy. In turn, commodity-dependent EM currencies are susceptible to devaluation as conditions facing industry and exports degrade.
Unfortunately for many emerging economies, the COVID-19 contagion sent commodity prices tumbling. During the height of pandemic uncertainty, the values of most earth-borne raw materials plummeted. Below is a look at the March 2020 performance for several leading commodity futures contracts:
- Corn: The price of December 2020 corn futures fell by 5.17% for the month.
- Beef: As COVID-19 disrupted the supply and slaughter chain, beef values plunged. December 2020 Live Cattle futures lost a staggering 10.60% amid March's market meltdown.
- Platinum: For the month of March, platinum proved why it is not considered to be a conventional safe-haven asset. Values of January 2021 Platinum futures crashed by 16.74%, losing more than US$145.00 per ounce.
- Gold: Gold bullion withstood a stark challenge from the USD as the world's premier COVID-19 safe-haven. Accordingly, December 2020 gold futures closed March near flat, posting a modest 0.88% gain.
- Crude Oil: Throughout the COVID-19 pandemic, the performance of crude oil was a lead financial story. For March, prices of December 2020 WTI crude oil futures crashed by a staggering 26.83% as a supply glut prompted a historic market correction. Devaluation.
The primary reason for lagging commodity prices was an overwhelming lack of demand. COVID-19 prompted an unprecedented global shutdown, and the result was mass capitulation as industrial and retail demand for commodities dried up nearly overnight. Subsequent devaluations in EM currencies that relied on oil, metal and agricultural exports ensued as the financial world reacted to extreme demand-side uncertainty.
The onset of the 2020 COVID-19 pandemic posed a collection of unique challenges for emerging market currencies. Periodic market volatilities prompted widespread value destruction in risk assets and commodities. Further, investors rushed into safe-haven assets, led by the USD, for insurance against the unknown. Subsequently, EM currencies were hit hard as the future of global economic growth and negative investor sentiment prompted devaluation.
However, many economists argue that EM currencies are better equipped to rebound from COVID-19 than the global majors. In response to the downturn, the central banks of some developing nations are expected to stand firm on policy issues while the world's prominent central banks enact aggressive quantitative easing (QE) measures. This discrepancy in monetary policy may attract investors to EM currencies as higher yields could make them popular "escape vaults" for individuals seeking extraordinary returns.
Ultimately, the post-COVID-19 performance of EM currencies will depend upon global social and economic health. Assuming an orderly recovery period and no viral "second wave," forex valuations of EM currencies are likely to represent true market conditions, not the COVID-19 panic trading of Q1 and Q2 2020.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…