The U.S. dollar’s strength last year overwhelmed emerging-market currencies, wiping out returns, even for stocks with good fundamentals. Will that happen again in 2016?
The recent currency pain has been most acute for oil and other producers of commodities, such as Russia, Brazil, and Nigeria. As the Fed raises rates, boosting the dollar, currencies in many commodity-driven economies will remain vulnerable.
That’s because commodities tend to be priced in dollars. So when the greenback is strong, they require more foreign currency to buy. The added expense usually weakens demand and keeps a lid on prices. Couple that with slack demand from big consumers, such as China, and an oversupply of oil, and you have the makings of prolonged weakness.
However, the hard-hit Russian ruble and Mexican peso could prove to be exceptions in the first half of this year, some strategists contend. That’s not to say that the ruble and peso will enjoy a big tail wind, but they may not face a big head wind, as they did in 2015.
The ruble and the peso were the worst-performing currencies in January, in parallel with oil’s slip below $30 a barrel. Société Générale currency expert Bernd Berg notes that the U.S. dollar/Russian ruble relationship has dropped from around 50 rubles to the greenback in May 2015 to 86 in the third week of January, before settling below 80 after the European Central Bank calmed markets with promises of monetary intervention.
Berg thinks that oil prices can stabilize and that investors will regain their appetite for oil-related emerging-market currencies. He expects the ruble to strengthen to around 75 to the dollar in the first quarter, and to 73 in the second. He thinks that volatility will be high, but that “the current ruble relief rally has some room to run.” Even Russia’s central bank recently said that the ruble is near levels of fundamental value and that it won’t need to intervene unless there are risks to the country’s financial stability.
MEXICAN PESO WEAKNESS reflects the low price of oil and ill-timed energy reforms. But it doesn’t account for economic growth near 3% this year and next–what SocGen’s Berg calls “the best fundamentals in the emerging-market universe.” He thinks the peso can strengthen to 17 against the buck in the next few weeks from more than 18 last week. The peso has tumbled roughly 20% against the dollar over the past year, making it the most undervalued Latin American currency. While low oil prices and slower U.S. growth are risks, peso weakness is overdone by about 9%, Bank of America Merrill Lynch estimates.
The outlook for other petroleum producers is bleaker, owing to political risk and near total dependence on oil revenue.
In Nigeria, for instance, policy makers have been unable to adequately diversify exports and improve policies. The African nation has pegged its currency to the buck since February 2015, but has restricted the dollar supply and some imports, causing its currency, the naira, to depreciate rapidly in the black market. The government has promised to defend the naira and could be forced to break the peg. Inflation and economic turmoil are inevitable either way.
In Brazil, political turmoil, the corruption and debt crises at oil producer Petroleo Brasileiro, or Petrobras (ticker: PBR), and stubborn deficits could further weaken the real, down by more than 35% against the dollar in the past year.
original source: http://www.barrons.com/articles/improved-outlook-for-russian-ruble-mexican-peso-1454131675