Shock Rally in Emerging Currencies Vindicates BlackRock

  • Templeton, BlackRock’s market calls proved to be prescient
  • Rising forecasts dominated by developing-nation exchange rates

It’s better late than never for BlackRock Inc., Franklin Templeton and a small cadre of influential money managers that six months ago called for a rally in emerging-market currencies. Now, the rest of Wall Street is starting to believe their strength may last.

An MSCI Inc. gauge of developing-nation exchange rates has climbed to the highest in 13 months and is on course for the first annual advance in four years. Strategists are rushing to raise their forecasts to keep pace with the gains: eight of the 10 currencies to receive the biggest upgrades since the end of the first quarter are from the developing world.

While easy-money central bank policies have pushed yields on more than $10 trillion of bonds in Europe and Japan below zero for some time, it’s now starting to dampen currency volatility, making higher-yielding assets in emerging markets even more appealing. Capital flows also underscore investors’ confidence in the outlook for developing-nation economies.

“This has become a golden year for emerging markets, and at the moment it looks like it’s still got some way to run,” said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp. in London, who recommends buying the South African rand, this year’s second best-performing currency. “The broad story of the search for yield should still make emerging markets that much more attractive at a time when the developed world seems to be heading for ever-cheaper rates.”

Year-End Forecasts

While their forecasts have been rising, strategists’ projections still haven’t caught up with the markets. Current estimates call for every emerging-market currency to decline through year-end.

Analysts have increased their median year-end estimates for the Brazilian real by 27 percent since March, the biggest revision in the world. They predict the Brazilian currency will end the year at 3.4 per dollar, or 7.5 percent weaker than Tuesday’s close at 3.1454. Forecasts for the Colombian peso have been lifted by about 11 percent since March to 3,072 per dollar, while the Russian ruble’s projection has been upgraded by 7.5 percent to 67 per dollar.

The 10 percent rally in the MSCI Emerging Markets Currency Index from an almost seven-year low in late-January marks a sharp turnaround for developing nations. Back then, the lowest oil price since 2003, China’s economic slowdown and prospects of higher U.S. interest rates all contributed to broad weakness in emerging exchange rates.

BlackRock, Templeton

During the rout, some investors foresaw the rebound. Research Affiliates LLC, which helps manage Pacific Investment Management Co. funds, said in February that developing-nation assets may be the “trade of a decade” after three years of underperformance made their valuations attractive. The same month, BlackRock, the world’s largest money manager, urged investors to buy emerging-market debt, while Templeton’s star bond manager Michael Hasenstab echoed the bullish view, favoring currencies such as the Mexican peso, Malaysian ringgit and Indonesian rupiah.

Those calls have proved to be prescient.

The MSCI index has soared since its low point as the Federal Reserve delayed an increase of borrowing costs to support growth, which helped weaken the dollar and boost emerging-market currencies.

Record Inflows

Over the past 10 weeks, investors added about $14 billion to exchange-traded funds that buy emerging-market stocks and bonds, boosting the inflows this year to a record $15.3 billion, according to data compiled by Bloomberg.

Stephen Jen, a former economist at the International Monetary Fund, said he’s giving up his long-held bearish view on developing-nation currencies -- for now.

“As long as the developed-market central banks remain dovish, high-yield currencies could continue to perform well,” Jen, now chief executive officer at Eurizon SLJ Capital Ltd. in London, said in a note to clients on Aug. 5. “This is a change in my view, and a belated admission that some emerging-market currencies have grossly undershot and the hurdles for them to rally were extremely low.”

Economic Recovery

Citigroup Inc. is skeptical. A further decline of oil prices, which have dropped 17 percent from a June peak, could pressure the currencies of commodity producers, such as the ruble, analysts led by Dirk Willer wrote in a report last week. Meanwhile, weakness in European banks could also spread risks to emerging-market currencies.

“We remain relatively neutral on EMFX,” Willer wrote in the report dated Aug. 4. “A clear bottom in oil is needed for a tradable EMFX rally, even if European banks do not morph into a global macro risk factor.”

Economic growth in developing nations is showing more signs of recovery. Markit’s gauge for manufacturing sectors in emerging markets rose in July to the highest since February 2015. The International Monetary Fund predicted last month that developing country growth this year would accelerate to 4.1 percent, from 4 percent in 2015.

“Fundamentals in emerging markets are, finally after three years of adjustment, improving,” Pablo Goldberg, an emerging-market bond manager at BlackRock, said on Bloomberg Television last week. “So it is at a good place to receive this money that is flying away from negative yields.”

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