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Wild Swings? Emerging Currencies Have It the Worst

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The recent volatility in global markets looks tame compared with the wild swings in emerging market currencies as investors brace for a possible early-end to the Federal Reserve's hefty monetary stimulus, strategists say.

The Mexican peso has shed about 6 percent over the past three weeks against the U.S. dollar, the Brazilian real has tumbled about 5 percent and the South African rand tumbled 2 percent on Wednesday alone.

The Indian rupee is close to hitting an all-time low against the dollar as fears mount about inflation and the country's trade deficit. The rupee hit 56.8 on Wednesday, edging nearer to the record low of 57.32 it reached on June 22, 2012.

The Turkish lira also fell to its weakest level since early 2012 against the greenback on Tuesday, although the currency has also been undermined by anti-government protests that have taken place in recent days.

(Read More: Turkey's Rulers Show They're No Good With a Crisis)

"Liquidity is disappearing, moves are very brutal, you can lose and win everything in a few minutes," said Sebasatian Galy, senior currency strategist at Societe Generale. "There is a shocking level of volatility in the emerging market space that hasn't reached the G10 [group of 10 developed] yet."

"We've seen very large shocks to key emerging markets such as Turkey and Brazil. Essentially if you look at the world, it's short dollar and long some emerging markets and some of the favorites are now suffering," he added.

The Fed's Beige Book survey on Wednesday describing the pace of expansion in the U.S. economy as "modest to moderate" stoked jitters about an unwinding of the Fed's quantitative easing, weighing on emerging market currencies.

The Fed's bond buying program has provided a steady stream of cash into emerging markets in search for higher returns and the worry is that a sharp withdrawal of that cash will knock investor appetite for risky assets, in turn hurting key emerging market currencies from Latin America to Africa and Asia.

(Read More: Why the Emerging Market Bull Run Is Over)

In a bid to stall an outflow of foreign cash and a sharp fall in its currency, Brazil this week decided to scrap a tax on foreign investments in its bond markets.

"Outflows are starting to happen and the fact that Brazil scrapped that tax is an indication of that," said Nizam Idris, head of strategy for fixed income and currencies at Macquarie Bank in Singapore.

"Look at where dollar/Brazil is; it's likely to go higher and that tells me outflows from emerging markets will last for a while," he noted, referring to the Brazilian real, which is trading around 2.13 per dollar.

(Read More: Sell Emerging Markets in May and Maybe June and July Too)

Idris said the most vulnerable currencies to an easing in U.S. monetary stimulus belonged to countries that have seen strong inflows into their bond markets due to the increase in liquidity in recent years, have a high current account deficit and are dependent on commodities.

"In short, that means Indonesia, Brazil and the South African rand," he said. "We're also quite negative on the [Malaysian] ringgit."

The Malaysian ringgit is trading around 3.09 to the dollar, down more than 4 percent from a peak hit almost a month ago.

Analysts said that while emerging markets were currently going through an adjustment process in terms of expectations for the Fed taking back its stimulus, the outlook may be not be as bad as feared.

(Read More: On Second Thought…Maybe Fed Tapering Won't Be So Bad)

"We all knew that one day the Fed would have to get out of that [quantitative easing] and as they talk about it there would be some changes, but overall I think we are in a decent position," said Richard Boucher, deputy secretary general of the Organization for Economic Co-operation and Development, replying to a question on CNBC Europe's "Squawk Box" about the impact of Fed tapering on the world economy.

"You will see rebalancing but the growth prospects are still in the emerging markets so you are going to see people investing here," he added.

- By CNBC.Com's Dhara Ranasinghe, Follow her on Twitter: @DharaCNBC

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