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Emerging markets: Currencies weighed down by inflation nerves

Emerging market currencies traded mixed on Wednesday as investors awaited U.S. inflation data that could sway the Federal Reserve’s accommodative policy stance, and as sentiment was dented by surging inflation in China.

China’s factory gate inflation hit a 26-year high in October and consumer price rises also quickened, primarily on soaring energy costs led by a shortage of coal resources.

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MSCI’s index of emerging market currencies was flat, with investors now awaiting U.S. inflation data which is expected to show a jump to 5.8%, its highest in over three decades.

While most Asian currencies held their ground, Turkey’s lira slipped 0.7%, and South Africa’s rand dropped 0.4%.

The drop in rand came a day after state utility Eskom said the risk of power outages would remain until another 4,000 to 6,000 megawatts of capacity was added to the grid.

For the first time, there is real concern about the stability of the grid
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“I don’t see U.S. CPI adding more to the pressure EM currencies currently face since expectations are already for it to jump past previous levels, but if inflation cracks the 6% level today we will definitely see ripple effects in FX and bond markets in the EM space,” said Simon Harvey, a senior FX analyst at Monex Europe.

Such high inflation levels could see U.S. bond yields rise, and raise rate hike bets by the Federal Reserve in its upcoming policy meetings.

Higher developed market rates raise debt burdens and trigger capital outflows from foreign institutions invested in emerging markets. It also narrows interest rate differentials which make EM currencies attractive for carry trade.

“It is a case of which currency is more sensitive to yield moves and which central banks are not moving according to inflation patterns like the rand and the lira, with the rise in Chinese price naturally leading to some pressure in the EM space,” Harvey said.

Russia’s rouble, meanwhile, tacked on 0.5% thanks to rising oil prices. The finance ministry’s OFZ bond auctions are also seen supporting the currency.

The dollar index rose against major rivals after weakening in the past three days.

EM stocks erased early losses to traded up 0.2% on gains in some tech stocks in Hong Kong and Taiwan >. Most bourses outside Asia also rose.

Fears of contagion from China’s embattled property sector remained with China Evergrande Group due for an offshore bond payment on Wednesday, while developer Fantasia Holdings plunged up to 50% after it said there was no guarantee that it would be able to meet its financial obligations.

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