Wall Street Braces for Emerging-Market Jolt by Dodging the U.S. Dollar

Updated on
  • Developing nations extend 20-month rally against U.S. dollar
  • GAM, UBS shifting strategies in fear of stronger greenback

After two years of almost uninterrupted gains in developing-nation currencies against the U.S. dollar, it’s time for a new strategy.

That’s the assessment of traders who’ve grown anxious that the greenback’s 16 percent slide against a basket of emerging-market currencies since January 2016 has gone too far. The latest inflation reading in the world’s largest economy added to concern, possibly giving the Federal Reserve cover to tighten monetary policy. At the same time, runaway growth in Europe and Canada have punished the dollar, making it ripe for a rebound.

That’s not to say the run in emerging markets is over. Signs that China’s demand for resources will remain robust and improving current-account deficits indicate that economies from India to Ghana can continue to expand at rapid rates, bolstering their currencies.

“The upward trend in emerging-market currencies is still in its infancy,” said Anders Faergemann, a senior fund manager in London at PineBridge Investments, which oversees about $80 billion globally and is diversifying its funding currencies from the U.S. dollar to the euro and Swedish krona. "Given the current outlook for growth and inflation, long-term investors should be using potential U.S. dollar strength to reassess their exposure."

For Paul McNamara, who oversees $8.6 billion in emerging-market debt as a money manager at GAM UK Ltd. in London, it’s also time to start using other funding currencies, including the euro and the Australian and Canadian dollars. 

While he says that no developing-nation currencies look “super cheap and super attractive” after the two-year tear, there are sill trades that make sense. McNamara has turned his focus to the Brazilian real, Indonesian rupiah and Malaysian ringgit. 

Brazil’s currency will benefit from improving balance of payments and growth, while Indonesia is a high-yielder with a revamped credit path and Malaysia remains cheap with a solid external trade balance, he said.

MSCI’s gauge of emerging-market currencies rose 0.3 percent at 12:10 p.m. in New York.

Lucy Qiu, an analyst at UBS Wealth Management’s Chief Investment Office, which oversees strategy for $2.2 trillion in assets, advises clients to use the Singapore dollar to buy the Indonesian rupiah and Indian rupee. Upside on the island nation’s high-yielding currency appears constrained by central bank policy, while India and Indonesia will likely benefit from improving external balances and built up currency reserves, she said.

Within emerging-market currencies, Qiu prefers selling South Africa’s rand for the Turkish lira, betting that political volatility in Ankara wanes while Jacob Zuma’s plan for “radical economic transformation” faces a test at the African National Congress’s leadership conference in December.

McNamara is also cautious toward the rand for similar reasons. But his biggest concern remains a stronger dollar, which would cause outsize problems for the Mexican peso and Central European currencies like the Czech koruna. After poring over positioning surveys, options data and other technical variables, he can’t see the greenback’s slide continuing much longer.

“The U.S. data just isn’t that bad,” McNamara said. “Our main concern is, what can go wrong from here? The world and its dog hate the dollar right now, and that’s worrying us a bit.”

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