Bund Sell-Off Steeper Yield Curve and EM Currencies


The 2Q15 Bund sell-off provides a good guide for the future The general USD strength has been a function of (a) market pencilling higher probability of Fed’s rate hike; (b) rumours of ECB QE tapering that weighed on EM FX. Looking ahead, the balance of importance between the two drivers will be crucial for USD price action. The former should lead to the general across the-board USD strength, albeit limited (as sooner or later, rate hikes will be sufficiently priced in). The latter is likely to lead to a non-linear USD strength, with dollar appreciating against non-European FX, but struggling heavily against EUR and its related currencies. This is because one by-product of the ECB QE tapering would be a sell-off in longer dated Bund yields (pushing global yields higher, thus inducing a risk off environment), rather than domestic USD drivers (ie, Fed rate hikes). Recall that during the Bund sell-off period of 2Q15, 10-year Bund yield increased from 0% to 1%, causing EUR/USD to rally by almost 10 big figures (which in turn supported other European G10 and CEE FX), but USD did well against EM FX high yielders. In the EM FX space, should the bund tantrum speculation intensify, expect CZK to be the best performing EM currency.

Steeper G10 yield curveshave provided headwinds for EM currencies, but the impact is unlike and much smaller relative to 2013/14. Back then EM had larger foreign funding requirements and when high private sector leverage slowed down, the EM supportive growth differentials declined. It was only yesterday that IMF’s Obstfeld cited additional DM growth risks while simultaneously presenting a better EM growth outlook. It seems China’s economic support program has developed growth supportive spill-over effects into EM. This does not mean that EM investments do not come with risks, but it will not be along the lines of the 2013/14 sell-off when higher US yields worked as the catalyst.