Rand set to drop further when Fed hikes

Emerging market currencies will weaken further when the U.S. Federal Reserve hikes interest rates for the first time in almost a decade, although for now investors appear relatively calm about the prospect, a Reuters poll found.

The currencies remain vulnerable despite a disappointing start to the year for the world's largest economy, which has pushed the likely timing for the first Fed rate rise from around now to later this year, likely September.

"Be prepared for a considerable shock when the Fed lifts off," BNP Paribas' Latin American foreign exchange analysts, led by Gabriel Gerzstein, wrote in a research note.

Although much of the eventual increase in U.S. interest rates has been priced by currency traders, illiquid spots in global markets could force investors to square positions aggressively, Gerzstein notes.

A recent example is the sharp increase in German Bund yields. Also, in 2013, when the Fed first hinted it would reduce the stimulus propping up the U.S. economy, markets responded by selling riskier assets in emerging markets.

Forecasts for the rand, the Brazilian real and the Turkish lira show the dollar is on standby to unleash another assault six months from now, although probably on a smaller scale.

"A renewed bullish tone in the dollar is expected to last as Fed rate hikes approach, and whilst much of this has been priced in, there is still scope for emerging currency losses as players adjust positions," added Christopher Shiells, a analyst at Informa Global Markets.

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Emerging market economies are not without home-grown problems.

South Africa is mired in chronic power shortages that are undermining investor confidence, while Brazil appears likely to fall into its worst recession in a quarter century as the central bank jacks up interest rates to curb inflation.

According to Shiells, South Africa's stagflation scenario should prompt further losses in the rand. The median forecast in the Reuters poll projects the currency to weaken to 12.35 in 12 months, from 12.26 currently.

For Brazil, the poll projected the real at 3.27 in 12-months time, from 3.14 currently, even as benchmark interest rates rise above 13 percent and make local assets particularly appealing to carry trade investors.

According to Shiells, the rate hikes will not shelter the real because of the sharp economic contraction this year and twin current account and budget deficits.

The outlook for the Turkish lira was clouded by a national vote on June 7. The prime minister is pushing for sweeping new executive powers through constitutional change, but may not secure a big enough majority to carry them through.

"We stay bearish on the lira ahead of the elections, the outcome which is far from certain," said Gabor Ambrus, an emerging markets analyst at RBS.

- Reuters