Emerging market currency

The currency of an economy that index providers classify as emerging rather than developed, a group that conventionally includes the Mexican peso, the South African rand, the Turkish lira, the Brazilian real, the Polish zloty and the Indian rupee. The classification belongs to the providers who build country indices, principally on tests of market size, accessibility and settlement infrastructure, and they do not agree with each other, so the membership of the group differs depending on whose list is consulted.

Several trading characteristics tend to travel together in this group. Depth is concentrated in the local session and thins sharply outside it. Quoted spreads are wider than in the major pairs and widen further around domestic policy events. Nominal interest rates are often high, which shows up in the financing applied to positions held overnight. And the exchange rate regime is frequently managed rather than free floating, so a central bank may intervene, or a rate may move very little for months and then reset.

The trap sits in that interest rate. A high domestic rate produces a financing credit on one side of a position and a debit on the other, which is why these currencies feature in discussions of the carry trade. A carry differential is not a return: over time the currency with the higher rate has often depreciated against the lower-rate currency, and the depreciation can arrive as a single large move rather than gradually. Holiday calendars are a second trap, because a local market closed for a national holiday leaves a quotation with almost nothing behind it.