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Traders who anticipated lower interest rates in developing nations are reversing course as prospects for reduced Federal Reserve economic stimulus sparks the worst rout in emerging-market currencies since 2001.
Just a month ago, central bankers in Mexico , India and South Korea were expected to pare borrowing costs at least once, according to interest-rate swaps data compiled by HSBC Holdings Plc. Now, the measures show no chance of cuts. Traders anticipate one more reduction in Poland and Hungary, instead of the two they expected a month ago.
Fed Chairman Ben S. Bernanke said June 19 that $85 billion of monthly bond purchases may end by mid-2014, helping drive this year’s 7.8 percent slide in India’s rupee and 7.5 percent drop in the Polish zloty. Weakening currencies are threatening to ignite inflation, forcing central banks in emerging markets to curtail interest-rate cuts even as their economies expand at the slowest pace since 2009.
“You’ve got this conundrum for the central banks where they are suffering from weakening growth at the same time as currency selloffs and capital withdrawals make it difficult for them to respond,” Matthew Lehmann, a strategist at JPMorgan Chase & Co., said in a June 25 interview from New York . “There’s very limited room to ease.”
Developing-country currencies tumbled an average 5.4 percent in the first half, the worst for the period since 2001, as investors pulled $32 billion from stock and bond funds in a reversal of the “monetary tsunami” that Brazilian President Dilma Rousseff said was pouring into emerging markets in March 2012. South Africa ’s rand led declines, plunging 14 percent. Brazil’s real sank 8.1 percent while South Korea’s won declined 6.8 percent.
Faltering Growth Outflows are quickening, with investors withdrawing a record $5.7 billion from bond funds in the week through June 26 after Bernanke said he would cut back stimulus as the U.S. labor market improves, EPFR Global data compiled by Morgan Stanley show.
Growth is faltering in emerging markets just as it shows signs of strengthening in the world’s biggest economy. Developing nations expanded 4 percent in the first quarter, the least since 2009 and down from average expansion of 6.4 percent over the past decade, according to Capital Economics.
Lowering interest rates to counter the slowdown could trigger additional currency declines and drive up prices on imported products, said Steffen Reichold, an emerging-market economist at Stone Harbor Investment Partners LP, which oversees $66 billion.
Slowing Inflation “A large majority of the central banks are done,” Reichold said in a June 26 telephone interview. “They want to keep the rates steady to see how long the pressure on the currencies will last. Nobody will do anything aggressive.”
While the currency losses threaten to fuel inflation, the most recent data show consumer price increases have been easing. The annual inflation rate in developing economies fell to 3.38 percent in May, the lowest in at least two years, according to data compiled by Bloomberg. That slowdown will help allow policy makers in countries including Hungary and Mexico to reduce interest rates further, ac
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