Analysts suggest that the prospect of a lasting peace agreement between the United States and Iran has triggered a rally in emerging market currencies and bonds, which could mark the beginning of a more robust uptrend.
Following the announcement of an interim agreement by the U.S. and Iran to reopen the Strait of Hormuz, the MSCI Emerging Markets Currency Index rose on Monday. JPMorgan Chase upgraded its rating on emerging market currencies to overweight last week. Wells Fargo noted that Asian currencies, particularly those linked to technology-driven economies, would benefit from improved market sentiment.
Since the war outbreak in late February, emerging market bonds and currencies have faced persistent pressure. Rising oil prices have burdened energy-importing nations, driving up inflation and heightening expectations for tighter monetary policy. The reopening of the Strait of Hormuz is expected to improve the outlook by lowering energy costs and alleviating pressure on policymakers.
"Markets have reacted positively to the potential progress from a deal, with risk assets rising," said Chidu Narayanan, Chief Asia-Pacific Strategist at Wells Fargo in Singapore. He added that emerging Asian assets are likely to find support, and "currencies of economies with a tech factor could benefit more," especially the South Korean won.
However, some analysts caution that a peace deal alone cannot erase the economic damage caused by months of high oil prices, particularly in emerging Asia, which remains vulnerable to rising energy costs and potential further monetary policy tightening by the U.S. Federal Reserve.
"The worst is certainly over, and we will see a rebound in emerging market assets," said Eugenia Victorino, Head of Asia Strategy at Skandinaviska Enskilda Banken. "But the war has dealt a heavy blow to domestic economies, and we still expect U.S. rate hikes. This will weigh on the economic recovery, and most currencies are unlikely to return to pre-war levels."
On Monday, the Indian rupee, Indonesian rupiah, and Philippine peso strengthened. During the conflict, these currencies had fallen to record lows against the U.S. dollar, prompting policymakers to implement measures to support their local currencies.
Sovereign bond prices in the region also rose, tracking gains in U.S. Treasuries. Thailand's 10-year government bond yield fell by 14 basis points on Monday, while South Korea's 10-year yield dropped by 9 basis points. Indonesia's 5-year bond yield plunged by 25 basis points.
Some analysts believe the market could extend its gains if falling oil prices coincide with easing inflation pressures.
In a report last Friday, JPMorgan strategists Fabio Bassi and Dubravko Lakos-Bujas wrote that a "goldilocks" scenario for macro markets in the second half of the year includes the reopening of the Strait of Hormuz, a significant retreat in crude oil prices, and a further slowdown in inflation driven by productivity gains from artificial intelligence.
"Against this backdrop, we are inclined to be long emerging market FX and rates, and remain positive on emerging market credit," they wrote.
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