For currency markets, the aftermath of prior global monetary tightening cycles has typically seen the dollar weaken in the first year after short-term interest rates have peaked in the major industrialized nations. However, emerging market currencies have usually softened against the dollar after prior tightening cycles, says Nick Bennenbroek, senior currency strategist at Brown Brothers Harriman in New York.
Investors taking a position in local equity or debt markets outside of their home country expose themselves to foreign exchange risk. In the past three rate cycles, some emerging currencies showed a consistent fall in the year after the end of a Group of Seven tightening cycle, according to Bennenbroek. The most notable examples included the Turkish lira, the South African rand, the Chilean peso, the Brazilian real and the Indonesian rupiah. But that is not necessarily compelling evidence of post-tightening weakness, Bennenbroek says. Some of those currencies tended to drop even more during a tightening phase.
The currency implications of monetary tightening may not be immediate, Bennenbroek adds. Interest rate futures do not predict a peak until early 2007, and BBHs analysis hints at the risk of even further tightening, he says.