Currencies like the Turkish lira and the Brazilian real may not always be foremost on investors' minds. But according to Scotiabank's chief FX strategist, Camilla Sutton, emerging market currencies are sending powerful signals about what the U.S. dollar will do next—and could convey a loud message to the Federal Reserve.
As the dollar has surged this year and oil has continued to crumble, emerging market currencies have felt the pain. The real has fallen 16 percent against the dollar year to date, dropping nearly a full percent on Tuesday alone—a huge move for a currency. The lira has been another big decliner, retreating 1.2 percent against the dollar on Tuesday, for a 13 percent drop on the year. And the Mexican peso is at all-time lows against the greenback.
Obscure as these moves might sound, Sutton says that if they intensify, they could actually cause the Fed to delay rate rises.
There would be precedent for such a market-based reaction by the central bank. Back in 2013, then-Fed Chair Ben Bernanke's suggestions that he would put an end to the quantitative easing program was met by big moves in bonds and currencies alike, which has become known as the "taper tantrum." Many believe that the reaction delayed the actual start of the tapering of asset purchases.
"When we have the taper tantrum that's still pretty close at hand, [emerging market currency moves are] really an important piece over all. And I think it's one of those pieces that does drive the Fed to be cautious once we have the first rate hike in," Sutton said Tuesday on CNBC's "Futures Now."
In other words, the central bank could view the emerging market reaction as a test of how profound the effects of rate rises would be. A big reaction, in turn, may delay the schedule of future hikes in rates.
In fact, Sutton says that when it comes to the dollar rise, "the Fed is oblivious to that—unless we get a really big shakeout out of the EM."
But there's another reason to keep a close eye on emerging markets.
Because EM currencies "led the move in things like the euro and other pieces, it's very important to be watching that for stabilization to give us clues that the rest of the move in the U.S. dollar will start to fade," she said.
"I think right now you can use that almost as a leading indicator," Sutton added.