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Inflationary Threats for Emerging Market Currencies

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Inflationary Threats for Emerging Market Currencies

The pandemic has created several supply chain disruptions. The lockdowns throughout the globe during the pandemic reduced the ability to load containers, creating shortages. The inability to send items initially was not a problem, but as countries started to emerge from lockdowns, shipping prices began to increase as goods became challenging to attain. Spot container rates to move items from one location to another via shipping lines are now three times the level at this point last year. The price is nearly double the 2020-average. Forex trading is becoming volatile as the dollar gains traction against most Emerging Market (EM) currencies. Despite declining U.S. yields, the dollar is gaining safe-haven strength as inflation begins to percolate. While inflation has yet to hit EM currencies, the Rise of inflation in the U.S. is likely to be transported to most EM countries.

Easy Money Generates Inflation

In the wake of the pandemic, the United States dropped interest rates to zero. With interest rates at zero in the U.S., getting money is easy and allows the velocity of changing money to accelerate. This phenomenon helps generate higher prices levels as the increase in cash rates makes it harder to get your hands on a dollar and increases prices.

Commodity prices are on the Rise

Most commodities are priced in U.S. dollars. The drop in the Fed Funds rate to zero helps generate growth and helps buoy prices. The synchronised upswing in commodity and energy prices brings relief to producers but eventually, the higher prices will begin to hurt the consumer of commodities. Net importers such as India and Turkey could feel the impact as they start to pay more for critical food and energy. Energy prices have reacted quickly, along with food prices. Global food prices are rising swiftly, hitting a fresh 11-month high in April.

Oil prices rebounded swiftly. After WTI declined in May of 2020 to negative levels, it has bounced back to $75 per barrel. Harsh growing conditions in the United States and drought are making it difficult to grow crops that have recently hit multi-year highs. The higher cost of food will be transferred to consumers pushing the final price of food and energy to higher levels. For net food and energy consumers, this rising price trend can become an issue. Emerging countries are seeing cost inflation which is different than inflation driven by demand. The combination of higher commodity prices and rising shipping rates drives up the final price of a product consumed by the end-user.

Emerging Market Forex Trading

The decline in U.S. yields initially helped EM currencies remain stable. Since the beginning of the pandemic, a stronger dollar against EM currencies has increased the cost of commodities, buoying inflation. Since most commodity items are quoted in U.S. dollars, a stronger dollar could boost inflation.  Volatility in the EM forex trading space has also become more of an issue as traders wonder whether these economies will remain sustainable in the wake of higher inflation levels.

Growth Has Been Hampered

The pandemic has also generated headwinds for growth. Countries that have been unable to roll out a vaccine are feeling the pinch. Countries that rely on tourism are likely to be the last countries that experience a rebound in the wake of the pandemic. Countries with proximity to developed countries that have seen a rollout of the vaccine are likely to see an uptick in growth. Forex trading in countries experiencing visits during the summer from developed nations may benefit more than those that attract visitors.

The Bottom Line

Emerging market forex trading has been volatile, and with low global yields and a weaker dollar, there is a continued threat of higher commodity prices. Rising shipping rates have generated inflation across the globe. While solid growth could help mitigate increasing inflationary pressures, inflation may continue to be an issue for EM countries during the first half of 2021.

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