Interest Rate Spikes and Inflation Relative to The Inflation of The Currency to Which The Country is Pegging

So whenever one sees the interest rate on peso denominated assets (peso here stands for the currency of the country that might have a crisis) being higher relative to a comparable US asset, that is a signal that the market expects a depreciation of the currency. The larger the differential, the larger the expected depreciation (currency collapse). When looking at the behavior of the Mexican interest rate relative to the US rate right before and during the Tequila crisis, the Mexican real exchange rate collapsed by more than 40%.

If inflation of the country that fix the exchange rate (say Argentina) remains higher than the one of the anchor currency (say US) this implies that Argentina will lose competitiveness relative to US and have lower foreign demand. To see this remember that the cost of American Goods relative to Argentinian goods is given by PUSe/PArg . If e is fixed and PArg grow faster than PUS , this means that Argentinian goods are getting more expensive relative to US goods. This creates more incentive for Argentina to devaluate to regain competitiveness.

Notice for example that in the Turkish crisis of 2001 even when the devaluation relative to the dollar was basically at 0 (in the second half of 2000) inflation rate in Turkey was much higher than US inflation, so Turkey was losing competitiveness.