Emerging Market Risk Tones
Quick question from Patrick asking, does risk tones also affect emerging market currencies.
Now first of all, Patrick, thanks for the question. To your question, yes, there is often a very strong correlation between overall risk tones and emerging market currencies, such as the Mexican peso, the Russian ruble, South African rand, etc, and that’s normally the case due to the high beta status.
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Now emerging market currencies are often considered as high beta currencies alongside currencies like your Australian dollar, Kiwi dollar, Canadian dollar, and that term high beta is more commonly associated normally with stocks, and it usually tries to gauge a stock’s volatility in relation to overall market volatility.
For example, gauging a stock’s overall volatility versus something like the S&P 500. Now in that same sense, when referring to currencies, high beta can simply just be described as currencies with a higher volatility and basically a higher risk profile, though it is likely more complicated than that.
Now, the reason why certain currencies are more sensitive to volatility can be due to a couple of factors. For most of it, it’s basically just they’re linked to commodities.
For example, Australia is highly geared to mining and is very sensitive to basic materials. Canada is highly dependent on oil, which means the Canadian dollar is sensitive to oil prices. And now some emerging market currencies are also highly correlated with commodities, such as the Russian ruble, with oil prices, as well as the Polish zloty to copper prices, which also puts them in that high beta bucket.
Now as a side note, there is currencies like the Norwegian krone, for example, which isn’t really considered as an emerging market and an emerging market currency, but due to its high dependence on oil, and much more than something like the Russian ruble and Canadian dollar, it is also considered as a high beta and can have very wide volatility ranges.
Now another reason, apart from commodities, why emerging markets are considered as high beta is due to the risk profiles. So countries, for example, like South Africa, often has much higher interest rates and higher government bond yields compared to some of your more developed markets, which does attract investors.
So when risk is on, investors flock to buy equities and bonds from these countries in basically search of higher yield and more risk or higher reward. But that higher yield and reward does come at a price and with a risk as these countries are often troubled by political and social unrest, corruption, etc.
Now the high beta status of emerging market currencies often make them more susceptible, as well, and sensitive to overall risk tones. But they are tricky to trade because all of them will also have the more let’s call it individual influences, as well.
So some of them might be influenced, like we said, by commodities, by maybe political issues, by unrest, by corruption. And that is apart from just the overall regular monetary and fiscal policy implications, as well.
So they can be sometimes tricky to trade, but in the general sense, we would expect them to also appreciate in risk on environments and depreciate in risk of environments alongside your more traditional high betas, like your Aussie, your CAD and your Kiwi.