Rout in Emerging-Market Currencies Gets No Trader Respect

  • Options protecting against declines near cheapest since 2014
  • Goldman, HSBC remain bullish while BlackRock sees rally fading

The selloff in emerging-market currencies that has shocked investors out of a torpor in recent days is being taken as little more than a nuisance than the beginnings of a bear market. 

While the MSCI Emerging Markets Currency Index has fallen 1.7 percent in a four-day slide that started Sept. 9 after gaining more than 10 percent from its January low, derivatives show the premium traders are paying to protect against further declines is about the lowest since 2014.

For all the hand wringing over the recent gyrations, investors at OppenheimerFunds Inc. and Aberdeen Asset Management Plc say improving economies in developing nations and dovish monetary policies in major markets still favor riskier currencies. Recent data show signs of China’s economic growth, Brazil and Russia are poised to emerge from their slumps and emerging-market nations have also boosted their foreign reserves by $144 billion to $9.9 trillion after they sank to a three-year low in March.

“From a global perspective, the drivers to our EM bullishness remain in place -- the Fed’s on hold, China’s stable, commodities are relatively stable,” said Daragh Maher, New York-based head of U.S. currency strategy at HSBC Holdings Plc. “You’ve still got the ingredients here to extend an EM rally.”

Redemptive Year

It’s been a year of redemption for developing-nation currencies, following years of underperformance. Back in January, emerging assets were damped by the lowest oil price since 2003, signs of China’s economic slowdown and forecasts for as many as four U.S. interest-rate increases.

MSCI’s currency index has soared since then as the Fed delayed an increase in borrowing costs to support growth, in turn weakening the dollar. Meanwhile, economic activity in developing nations has shown signs of recovery. Companies in MSCI’s Emerging Markets Index posted average growth in earnings-per-share of 47 percent in the last quarter as S&P 500 Index members’ profits fell.

Bloomberg Intelligence: Sluggish Economic Growth Justifies Glacial Fed Pace

Options traders are showing a waning bias for the greenback over emerging-market currencies. The average premium for contracts granting rights to buy dollars over the Brazilian real, South African rand and 21 other emerging-world counterparts have fallen to 2 percentage points from almost 3 a year ago, according to three-month risk-reversal rates tracked by Bloomberg. The figure fell below 1.8 percentage points in June, and that gauge’s 50-moving average is at its cheapest in two years.

The benchmark for the Brazilian real has had this year’s biggest net decline, to 2.7 percentage points, from 3.9 at the end 2015.

Expectations of broader currency swings in the options market have fallen to near the lowest since August 2015, as easy-money policies pushed yields on $11.7 trillion of bonds in Europe and Japan below zero, increasing the allure of higher-yielding emerging-market currencies.

“Investors are certainly searching for more attractive yields, and emerging markets are definitely where one can find some,” said Kevin Daly, a London-based portfolio manager for Aberdeen Asset Management, whose Emerging Market Debt Fund has outperformed nine out 10 peers in the past year.

Russia’s ruble and the Thai baht are among the best bullish bets in emerging markets, while the most attractive short wagers include China’s yuan, the Indian rupee, Colombia’s peso and Hungary’s forint, Deutsche Bank AG strategists Gautam Kalani and Jayant Gupta wrote in a report on Tuesday.

The bullish view is challenged by money managers at BlackRock Inc., which doesn’t see developing-nation currencies strengthening further. Now the world’s largest asset manager is betting on forwards that profit when developing-nation currencies depreciate less than implied by interest-rate differentials. Though emerging-market currencies have benefited from central banks’ cheap-money programs, policy makers now are questioning the benefits of additional stimulus.

“The undervaluation, the cheapness of emerging-market FX, is gone,” said Amer Bisat, co-portfolio manager of the BlackRock Strategic Global Bond Fund. “At this stage, FX is fairly valued, to, maybe on the margin, on the expensive side.”

This year’s rally has fueled the largest allocation to emerging markets debt and equities in years.

“Flows are still on the side of EM assets,” said Luis Costa, a currency strategist at Citigroup Inc., who recommends buying the Russian ruble and Brazilian real and selling the South African rand and Polish zloty.

From a historical perspective, allocations to developing-nation assets remain low, making it unlikely that the positions are stretched, HSBC currency strategists including David Bloom wrote in a note to clients Sept. 8.

The bank expects higher-yielding currencies like the South African rand and Turkish lira to outperform alongside currencies which are undervalued, such as the Mexican peso.

‘Glacial Pace’

High yields, unchallenging valuations and improving macro fundamentals should help emerging-market currencies navigate the potential for developed-market rate volatility in coming months, Goldman Sachs Group Inc. analysts including Ian Tomb wrote Sept. 9.

“If Fed rate hikes come, they will come at a glacial pace; that remains pretty comfortable as a backdrop for EM overall,” said Roxana Hulea, a London-based emerging-market strategist at Societe Generale SA. “We will see strong oscillations before the FOMC meeting, but I wouldn’t call it the end of the rally that we’ve seen since Brexit,” she said, referring to the Sept. 20-21 meeting of the Federal Open Market Committee.

Alessio de Longis, a OppenheimerFunds portfolio manager in New York, said the rally may even gain momentum. “If the Fed were to signal decisively that the hawkish bias is not there, EM may really have a much more powerful run,” he said.

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