Pain Trade to Turn to Joy for EM Investors Calling Euro TopBy and
BNP, Amundi, Fidelity see value in euro-funded carry trades
Morgan Stanley Investment favors franc, kiwi-funded strategies
Some emerging-market investors are learning to love one of the pain trades of the year. Just about.
BNP Paribas Asset Management, Amundi SA and Fidelity International Ltd. are seeing opportunities in betting on a weakening euro to profit from attractive carry in emerging-market currencies. Until now, dollar-funded strategies have led to returns this year in all but one of the 21 developing currencies tracked by Bloomberg, while using the euro yielded negative returns in 16 of them as the common currency surged amid speculation that the European Central Bank will exit quantitative easing next year.
For those willing to take the plunge, the argument goes like this: Much of the optimism driven by stronger growth in Europe, reduced political risks and a hawkish ECB has already been priced in. The dollar weakness partly fueled by the lack of progress with President Donald Trump’s fiscal policies and weak inflation data may start to turn as the Federal Reserve takes the lead in tightening before its European counterpart.
“Euro-funded carry trades make sense at this juncture,” said Guillermo Felices, senior investment strategist for multi-asset solutions in London at BNP Paribas Asset, which manages the equivalent of $675 billion. “We have now reached a point where both policy actions and macro data could start surprising to the upside. The risk of a lower euro versus the dollar in the next six to 12 months is material and that favors euro as a funding currency.”
The euro strategy is forecast to yield an average return, including interest income, of about 2.9 percent by the second quarter of 2018, while using the dollar would yield 2.4 percent, according to a Bloomberg survey of analysts. The common currency is predicted to weaken about 1 percent against the dollar by December from around $1.19 at 10:41 a.m. in London. It’s risen 13.6 percent this year after reaching a 2 1/2-year high earlier this month.
“Euro at $1.20 is trading at its fair value,” said Hakan Aksoy, a London-based emerging-market fund manager at Amundi, which oversees the equivalent of $1.5 trillion. “If we see higher euro levels, we will be more inclined to be long in local-currency markets.” He finds attractive exchange rates in Europe’s emerging markets as well as the Mexican peso.
Using the euro to fund carry trades is still far from universal. Morgan Stanley Investment Management would rather use the Swiss franc and the New Zealand dollar, the only ones to decline against the dollar this quarter among Group-of-10 currencies. The factors that have made the euro unattractive as a funding currency, such as the growth optimism in the euro region, remain in place, and dips in the currency are likely to be shallow, said Michael Kushma, the Wall Street firm’s New York-based chief investment officer of global fixed income.
“Many emerging-market currencies remain fundamentally undervalued based on our FX models,” said Sahil Tandon, a fund manager in New York at Morgan Stanley Investment, which oversees $435 billion. Among them are the Polish zloty, Mexican peso and Malaysian ringgit, he said. “Relative growth dynamics and a large real rate gap should continue to exert appreciation pressure on emerging-market currencies.”
Fidelity International, which has total client assets of $383 billion, is “broadly underweight” emerging-market currencies against the dollar as the Fed’s policy normalization pressures the asset class, according to a report by its fixed-income team. Yet it sees opportunities to add exposure to them by shorting the euro. They cite trades including buying the Turkish lira and Russian ruble against the common currency as “compelling” given their good carry at current levels.
Whatever the funding currency, value in the emerging world is likely to be found outside Asia. Currencies in the region are starting to look expensive based on real effective exchange-rate valuations, BNP Paribas Asset’s Felices said. The Brazilian real is an “interesting” opportunity for euro-funded trades as its yield is still high and capital inflows support the currency, he said.
“Markets have priced in a lot of optimism in Europe, which is now vulnerable to disappointment,” Felices said.