'Fragile Five' Emerging-Market Currencies Look Fragile Again as Fed Takes Root

The average cost of options betting on a decline in Brazil’s real, Indonesia’s rupiah, South Africa’s rand, Turkey’s lira and India’s rupee has jumped to the highest level in almost five months, data compiled by Bloomberg show. That follows an emerging-market boom that placed them among the top 10 best performers of the world’s 31 most-traded currencies in the past six months.

The increased anxiety about developing-nation currencies comes as U.S. preparations to lift interest rates threaten to draw investment away from riskier assets. Morgan Stanley coined the phrase “fragile five” in August 2013 to describe the currencies, which are particularly vulnerable because of their dependence on foreign investment to fund current-account deficits.

“Each month that goes by, you’re coming closer to the point when you’re going to be tightening,” Alan Ruskin, the global head of Group of 10 foreign exchange at Deutsche Bank AG in New York, said by phone. “You’re picking up pennies in front of the steam roller — you’ve got to be very careful indeed.”

Insurance Demand

The cost to insure against declines in the five currencies versus the U.S. dollar is on the rise.

An index that tracks the average of the one-month 25-delta risk reversal rates on all fragile five currencies was 1.79 percent, close to the 2 percent level reached last week that was the highest since March, data compiled by Bloomberg show. As recently as May, the premium had been the least in a year, at 1.16 percent.

“There’s more demand for insurance against the dollar’s appreciation,” Bipan Rai, director of foreign-exchange strategy at CIBC World Markets Inc., said by phone from Toronto. “A lot of those emerging-market currencies are vulnerable because a lot of them look overbought, or have been over the last seven or eight months.”

In the last six months, the real’s 5.4 percent appreciation made it the second-best major currency in the world, trailing just the Colombian peso’s 7.2 percent rally, according to data compiled by Bloomberg.

The rand’s 3 percent gain made it the sixth-best performer, with the rupee, the lira and the rupiah coming in seventh, ninth and tied for 10th.

Rate Speculation

Those gains have slowed as the U.S. has reported consistent economic growth in recent months. The most recent jobs report for July showed the U.S created more than 200,000 positions for a sixth consecutive month.

With the Fed on track to end its extraordinary stimulus program in October, investors are starting to consider the effects of the first U.S. rate increase in eight years on emerging-market currencies.

When similar considerations coincided with an unexpected slowdown in Chinese growth in January, Bloomberg’s index of 20 major emerging-market currencies fell 3 percent, the worst start to a year since 2009. South Africa’s rand fell to its weakest in five years and Turkey’s lira touched a record low as both countries’ central banks were forced to raise interest rates to stem the rout.

Global Turmoil

Contemplation of higher U.S. interest rates is accompanied this time by increasing concern about geopolitical turmoil. Tensions between the U.S. and Russia over Ukraine are rising in the midst of their worst standoff since the Cold War, while Islamist insurgents make territorial gains in Iraq and a lasting cease-fire between Israel and militants in the Gaza Strip remains elusive after more than a month of fighting.

“People buy the dollar on that and run away from emerging- market currencies that have any vulnerabilities,” Greg Anderson, head of global foreign-exchange strategy at Bank of Montreal, said by phone from Toronto. “They’re worried about a sharp deterioration in the geopolitical situation, they’re worried about rate hikes. Either one of those could cause these currencies to weaken dramatically.”