Hedge-Fund Bets Against Emerging Currencies Get Crowded

Updated on
  • Paamco says popularity of the trades is fueling volatility
  • Currencies of Malaysia, Brazil, Turkey are worst performers

Hedge funds are piling into bets that the dollar will strengthen against emerging-market currencies, especially those vulnerable to falling commodity prices, according to a money manager who invests in the funds.

The popularity of the trade will fuel volatility in those currencies should such funds adjust their positions, said Sam Diedrich, a director at Pacific Alternative Asset Management Co., which oversees about $9.5 billion in hedge-fund investments.

“It’s become a crowded trade,” Diedrich, who is based in Irvine, California, said in a telephone interview. “Long term, I still think the trade works, but you could see some large swings.”

A gauge of emerging-market currencies slumped to a record this week as China’s shock devaluation of the yuan on Aug. 11 triggered a rout in stocks around the world, sapping demand for higher-yielding assets. The currencies of developing nations -- from Malaysia to South Africa to Brazil -- were the worst performers against the greenback in the past month.

Junk Rating

China’s slowdown has damped prospects for commodity linked and emerging markets, with Standard & Poor’s cutting Brazil’s credit rating to junk on concern growth is slowing. A further devaluation of the the yuan may hurt Asia’s currencies, infecting emerging markets elsewhere, Diedrich said.

“A further devaluation of the yuan in the order of 5 to 10 percent would definitely not surprise me,” he said.

While traders have pared bets the Federal Reserve will raise interest rates when it meets next week, the prospect of monetary tightening as early as October will probably support the greenback, Diedrich said.

“Long-term structural bullish dollar positions are still out there,” he said. “There are a lot of reasons to think that U.S. dollar strength will continue for quite some time, particularly against emerging markets.”

The outlook for swings in global foreign-exchange rates as measured by a JPMorgan Chase & Co. gauge rose to a seven-month high this week. Malaysia’s ringgit slumped Thursday to the weakest level since January 1998, while Kazakhstan’s tenge was set for its lowest close after the central bank abandoned a currency peg last month.

“The volatility in portfolios has increased and it’s led to a good deal of de-risking,” Diedrich said. “Given the light positioning overall, I don’t think it’s a big trade necessarily in hedge funds to be betting one way or the other on a Fed hike.”