The recent re-pricing higher in US rates - driven by renewed expectations of tax reform and a steadily normalizing Fed - has led to a 3.5% sell-off in EM FX. Further, the external environment for EM FX in the near term remains uncertain, given risks around the next Fed chair appointment and an acceleration of US inflation. The summer Goldilocks period for EM has clearly taken a pause, and at this juncture it is important to assess how EM currencies stack up on ‘defensive’ metrics, which will play a role in how much pressure they come under if external financing conditions continue to deteriorate (for example, if core rates continue moving higher).    The three ‘defensive’ dimensions we focus on are real rates, FX reserves and current account/basic balance flows (which highlight the dependence on external financing). We combine the rankings on these variables to produce an overall ‘defensive’ ranking of EM currencies.    We find that on these metrics, THB, RUB and TWD have the best defenses, and therefore are likely to be less exposed to external financing shocks (i.e. rising core rates), while ZAR, TRY and CLP are vulnerable. See charts 1 and 2 for the full defensive rankings.    The performance of currencies since the bottoming out of US rates on 8th September broadly reflects this ranking: ZAR and TRY have depreciated the most vs. USD, while THB, TWD and RUB have suffered less.    RUB’s high ranking on defensive metrics is a significant part of the reason we remain long RUB; we believe it can perform well not only in a positive EM environment, but also in more difficult/uncertain environments. See our recent reports here and here.

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