Goldman Sachs – Emerging-Market Bulls Pin Currency Hopes on Hawks Outpacing Fed
(Bloomberg) — Emerging-market currencies hit by a hawkish Federal Reserve could soon regain their record run against the dollar on expectations that developing central banks may outpace their U.S. counterpart in policy tightening.
The currencies of Brazil, Russia, the Czech Republic, South Africa and Hungary — countries that delivered multiple rate hikes or are expected to do so soon — are retaining quarterly gains and outperforming peers. More may join their ranks, with tightening expectations growing for countries including Chile and South Africa as economic activity and inflation roar back from a pandemic-driven slump.
In comparison, the Fed has signaled it’s likely to lift interest rates only in 2023. While recent dollar gains have stalled the momentum in emerging-market currencies, that picture could change once the greenback’s support from positioning shifts fades, according to Bank of Singapore Ltd. and JPMorgan Asset Management.
“Emerging-market central banks are set to begin raising interest rates well before the Fed,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore Ltd. “Over the summer, lower volatility may induce investors to put on seasonal carry trades again to the benefit of higher yielding emerging-market currencies.”
U.S. financial conditions are closely correlated with demand for risk assets, including emerging-market stocks and currencies. While taper talk has been the focus of investors’ concerns, they should be watching for signs of tightening financial conditions, which could trigger a selloff, according to Neels Heyneke, a strategist at Nedbank Group Ltd. in Johannesburg.
That’s not happening yet, with U.S. conditions still near the loosest on record, according to the Goldman Sachs U.S. Financial Conditions index. And while gauges of emerging-market stocks and currencies have pulled back from all-time highs, they’re still well up this quarter.
With the Fed unlikely to hike in 2021 or 2022, “monetary and financial conditions should remain easy for some time,” said Didier Lambert, JPMorgan Asset Management’s lead portfolio manager for emerging-market fixed income. “EM central banks able to rein in inflation expectations in a credible way — such as Russia, Czech Republic or Brazil — may see greater demand for their currencies.”
While some commodities took a hit after the Fed’s latest rate signal, others remain supportive of emerging-market currencies linked to raw-material prices. Raw materials like copper, coal and iron ore hit all-time highs last month, with a rebound in the world’s largest economies stoking demand for metals and energy when supplies are still constrained.
That’s prompting Aberdeen Asset Management to take advantage of any weakness to add to its bullish bets on commodity-linked currencies such as the Brazilian real, as well as the Chilean and Colombian pesos.
“If anything, this is ratification that global growth is strong and so is the demand for commodities,” said Edwin Gutierrez, head of emerging-market sovereign debt at Aberdeen in London. “But let’s see how much of a shake-out there is in those.”
JPMorgan Asset Management plans to use any market volatility to invest in most emerging-market currencies that will benefit from a cyclical recovery and in selective high-yielding securities. Bullish positions in developing currencies aren’t “overextended,” suggesting that potential losses from a stronger dollar will be limited, said Lambert.
The shift toward tighter monetary policy in developing nations isn’t uniform, however. Some are continuing to support growth as the coronavirus continues to spread, or a new wave of cases emerges.
Central banks in Thailand and the Philippines look set to keep interest rates on hold this week, as the region battles persistent coronavirus outbreaks with only a fraction of the population vaccinated. Poland wants to keep monetary policy loose until the economic rebound is well under way, despite surging inflation.
That means investors should be looking for relative-value trades rather than buying the basket, according to Bank of America Securities, which favors Poland’s zloty over other Central and Eastern European currencies given cheaper valuations and a still relatively dovish central bank, giving it “more scope to reprice when they turn hawkish,” strategists led by David Hauner said in a report.
The Brazilian real has been the top performer among emerging-market currencies this month, followed by commodity-linked peers such as Russia’s ruble and Colombia’s peso. The forint, zloty and koruna have underperformed.
Brazil’s monetary authority hiked its key interest rate by 75 basis points and opened the door to even bigger increases on Wednesday amid surging inflation forecasts. The nation is among the first to increase its key rate to pre-pandemic levels, taking a more aggressive stance to battle inflationary pressures.
“Brazil is probably the clearest example of a combination of better growth prospects, reduced political noise, more hawkish central bank and undervalued currency to justify its recent outperformance,” the (BofA) strategists wrote.
Emerging-market local-currency debt posted its biggest weekly drop since March 2020 in the five days through Friday. It’s often seen as the most susceptible to any rise in the dollar or U.S. yields because either of those would reduce the carry return. A Bloomberg News study has identified that a 25-basis-point increase in yields in a month would be the tipping point for moves in higher-yielding currencies such as the Turkish lira, South African rand and Mexican peso.
“While we believe emerging-market currencies are undervalued on a real effective basis, the carry is fairly limited in most currencies,” said Nicholas Ferres, chief investment officer at Singapore-based hedge fund Vantage Point, who prefers to hold Asian stocks.
Some frontier currencies such as the Egyptian pound and Ghanaian cedi will probably hold up better than most of their peers given their “enormous” real-yield advantage, according to Fidelity International.
“A market shake-out over the summer will provide an attractive entry point to get back into emerging-market dollar debt, currencies and local duration,” said Paul Greer, a London-based money manager at the firm, which oversees about $700 billion. “We expect the total returns for the asset class to be better in the second half than in the first half.”
Hungary’s central bank on Tuesday is poised to start one of the region’s first monetary-tightening cycles to combat the fastest inflation in the European UnionThe forint was one of the biggest losers in emerging markets last week as economists’ forecasts on the size of a potential rate increase varyTraders doubted the central bank will deliver “decisive” monetary tightening, as promised by a deputy governorOn Wednesday, the Czech central bank is predicted by almost all economists to follow suit with a quarter-point hike to 0.5%Thailand and the Philippines will probably keep borrowing costs unchanged on Wednesday and Thursday, respectivelyPolicy makers from both countries are likely to signal “that they won’t adjust policy for quite a while to come,” said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc. “With domestic demand still hobbled by Covid-19 restrictions, there is little risk that rising commodity prices will trigger a surge in consumer prices”The Thai baht and the Philippine peso each fell more than 1% last weekChina’s one-year loan prime rate — the reference rate for bank loans to companies — will likely remain at 3.85%, according to a Bloomberg News survey ahead of data due MondayThe five-year rate — the reference rate for mortgages — will probably remain at 4.65%, another survey showed
Mexico’s central bank is expected to leave its key interest rate steady for a fourth month on Thursday
Traders will watch for any guidance on future policy as the nation’s TIIE curve prices in more than 70 basis points of hikes in the rest of 2021Traders will also monitor Mexico’s April retail sales data on Wednesday, bi-weekly inflation for the first part of June on Thursday, and April economic activity on Friday
Brazil’s central bank will release minutes from its most recent policy meeting on Tuesday, which may offer detail on the 75-basis-point Selic increase
The policy makers will also release a quarterly inflation report on Thursday, which will will likely bring a significant upgrade to the BCB’s growth forecast, according to Bloomberg EconomicsBrazil will post mid-June IPCA numbers on current account data for May on Friday
What Else to Watch
South Korea reports 20-day trade data on Monday
Bloomberg Economics expects tight supply and sustained demand for tech products to continue to buoy exports in the months aheadSouth Africa’s inflation probably accelerated to 5.2% in May, the highest in more than two years. That would be in line with the projection model of the central bank, which indicated last month that its interest rate will increase before the end of the yearThe rand was the hardest hit emerging-market currency last weekIn Argentina, investors will watch first-quarter gross domestic product figures on Wednesday for signs of a rebound compared with earlier in the pandemic
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