Buyer Beware as Nobody Trusts the Rally in Emerging Currencies

  • Darkening global outlook raises concern for Credit Suisse
  • Index recovers from historic low reached in September

The emerging-market currency index, whose components include the Brazilian real and the Thai baht, climbed for a sixth straight day Friday, paring its 2015 loss to 9.3 percent. The gauge has risen 3.6 percent this week.

Jobs Trigger

The trigger for the rally also serves to explain why the gains may be short-lived. The advance picked up steam after a government report showing the U.S. added 142,000 jobs in September, compared with the 200,000 median forecast in a Bloomberg survey of economists. Employment growth trailed projections in August as well.

Traders are pricing in a 39 percent probability that the Fed raises rates by its December meeting, down from 60 percent a month ago, according to futures data compiled by Bloomberg. The calculation is based on the assumption that the effective fed funds rate will average 0.375 percent after liftoff. Higher U.S. interest rates hurt the relative appeal of emerging-market assets.

"The reason you’ve had this recovery in higher-yielding currencies is you’ve had this setback for Fed expectations," said Daniel Katzive, head of foreign-exchange strategy for North America at BNP Paribas SA. "But if you think what the driver for that setback is, it’s external headwinds outside the U.S. Those same external headwinds are likely to continue impacting emerging markets."

Precarious Recovery

The currencies’ recovery is precarious given developing nations’ dependence on the world’s biggest economies, according to Credit Suisse and BNP. A commodities rout and waning Chinese demand have already led to contraction in manufacturing measures for some nations, Markit Economics data show.

“Emerging markets in general struggle to find a growth model outside of exports and commodities," Michael Gomez, head of emerging-markets portfolio management at Newport Beach, California-based Pimco, wrote in a report released this week.

Franklin Templeton’s Michael Hasenstab, who’s known for making contrarian bets, said this week the emerging-market selloff opened up opportunities not seen for decades. The San Mateo, California-based money manager is buying the Mexican peso, Malaysian ringgit and Indonesian rupiah, while avoiding assets in Turkey, South Africa and Russia.

Rough Diamonds

“We are not buying everything,” Hasenstab said in an interview posted on YouTube. “There are a handful that have been caught up in the turmoil that we think are diamonds in the rough.”

Morgan Stanley also sees a way to tap into the rally, although it anticipates that the gains will eventually fade. In a note this week, the bank recommended buying currencies of countries with robust growth potential, such as Mexico’s peso and India’s rupee. Yet developing nations remain vulnerable amid “subdued demand in the rest of the world,” according to the New York-based bank.

"Without a pick-up in growth, net capital outflows will remain negative and drive currency weakness," strategists including Gordian Kemen wrote in a note published Wednesday.

The rally is unlikely to last long as growth concerns in emerging markets and China remain, according to Citigroup, the world’s biggest foreign-exchange trader. A more solid rebound in commodities is needed, analysts at the lender led by Dirk Willer, New York-based head of emerging-market fixed-income strategy, wrote in an Oct. 8 report.

“What we’re having is a magnificent dead-cat bounce,” said Michael Every, the Hong Kong-based head of financial-markets research at Rabobank Group. “The underlying problems have not gone away in any way, shape or form. We had maybe gone too bearish too quickly before, but now we’re getting too bullish too fast.”

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