On December 18, 2013, the Federal Reserve (Fed) announced that it would begin to reduce the pace of its asset purchase program through a series of gradual steps referred to as “tapering“. When this program was first hinted at some seven months prior, U.S. interest rates rose rapidly through the end of the year, and many emerging market (EM) currencies fell in value against the U.S. dollar. Since that time, the Fed has reduced its bond-buying program from $85 billion per month to $25 billion through a series of measured cuts. With current projections forecasting that the Fed may end its asset purchase program on October 29,1 we thought it might be helpful to see how these currencies have reacted to the change in Fed policy thus far.
Interest Rates’ “Carry” Performance
While many investors tend to focus on changes of currency spot rates, a primary reason we have long advocated that investors allocate to EM currencies is the income potential driven by the higher interest rates in many emerging market countries. In today’s yield-starved environment, EM currencies remain one of the most significant means of generating income in a portfolio while limiting interest rate risk. Additionally, these higher levels of interest rates can help dampen the volatility associated with investing in emerging markets from a total return perspective. As we show in the table below, 11 out of 23 currencies appreciated against the U.S. dollar over this period. However, when adding in carry from higher rates, 15 out of 23 EM currencies generated positive total returns.2
Currency Performance: December 18, 2014 – July 31, 2014