Here are a couple of quick takeaways on the outlook for EM currencies, courtesy of the sell-side.
(Given the avalanche of reports in our inbox touting the asset class’s outperformance and the massive rally in EM currenciesso far this year, it would be rude not to.)
- In short, most analysts right now are defending the cyclical upturn in EM FX flows, citing a holy trinity, for now: yet-more G7 monetary stimulus, a couple of stronger-than-expected economic indicators in the US and China and still-cheap valuations of EM currencies.
- They are bullish on flows and valuations, arguing that the asset class was long overdue a correction. However, the pace of FX repricing will moderate in the coming months since any rally from February onwards will be coming from a higher base.
- In addition, investors should tread carefully given the global macro risks and snap up undervalued currencies in economies with strong fundamentals, rather than dodgy high-beta trades. And, as we have covered earlier, that’s certainly been the allocation trend in January, not least because portfolio managers need "to justify currency purchases on the basis of fundamentals," Koon Chow, EM strategist at Barclays Capital told us. In all, there has been sensible differentiation between currencies, says Chow. So far, "the good guys are winning," he adds.
- Finally, year-to-date, EM equities – a heavily growth-sensitive asset class – have outperformed EM credit and EM local currency government bonds. Given the modest but not insignificant uptick in positive sentiment towards US and Chinese growth prospects this year, that’s probably understandable. But few analysts have opined on what EM asset class is likely to outperform in 2012. So without further ado, here are some thoughts from Credit Suisse:
| Data and policy innovations have been almost universally positive for Asia over the past week. The Fed’s surprise extension of its commitment not to raise US rates from mid- 2013 previously to late 2014 now strikes us the key medium-term development. We see this increasing flows into the region, supporting currencies, but having more mixed implications for regional local currency yields. The stronger than expected euro area flash PMIs for January are the key cyclical macro driver we see for Asia. As we explained last week, they combine with the US ISM to signal Asia’s export cycle has troughed. This has historically been a consistent leading indicator of trend Asian currency appreciation. Additionally, we think the more the global PMIs surprise, the sooner talk of Asian rate cuts will come to an end, except in perhaps India. Focusing on the Fed, our bias is to expect this to increase flows of funds into the region. The Fed has essentially pushed out and increased confidence in the market’s expectation of the duration of low funding cost. Additionally, the Fed’s stance implies a weaker USD for longer which enhances the attractiveness of foreign yields funded in USD. |
From Bank of America Merrill Lynch:
| The risk rally since the start of the year has led the dollar to fall broadly over the past few weeks, especially against high-beta currencies. While markets had worried about the US being pulled down by the situation in Europe, we recently argued that the recoupling risk may run the other way. Better sentiment and data in the US may pull up the rest of the world, sparking dollar weakness in the short term. It does seems that this scenario has been playing out, with the market focus shifting away from Europe recently despite the lack of positive news, and concerns over a China hard landing seemingly allayed for now. ... A number of our forecasts have been changed in EM. We have reduced our USD/CNY forecasts to 6.32 for end Q1 and 6.20 for the end of the year, and revised a number of our Asia FX forecasts to reflect reduced pessimism. Our LatAm FX forecasts have been increased as well; in particular, we are now looking for more gradual weakness in BRL and MXN. While market sentiment has turned more positive, many of the previous concerns have not gone away, most notably those out of Europe. Nonetheless, a surprise resolution to the European crisis would be dollar negative, as would a continuation of the recent risk rally. A risk of a hard landing in China remains an issue, as does the risk of any flare-up in the Middle East. |
From Barclays Capital:
| We are not yet ready to call for profit taking in EM FX. While the rally versus the dollar in January has been strong, the global risk environment is still supportive. On the macroeconomic side of the equation for FX, recent news out of EM in particular has been, on balance, positive. Earlier in the month, cyclical data out of China were stronger than expected (monetary aggregates in particular and also GDP), and recently the PMI for the systemically import EM economies showed an improvement. This is surprising given that activity and sentiment were still weighed down by considerable uncertainty regarding the euro area in November/early December. The confluence of the above factors argues against turning cautious on EM currencies just yet. EM currencies offer (in some places) significant yield pick-up over the major currencies. Moreover, even after the spot appreciation of EM currencies in January, some of these currencies still have significant headroom before 2012 targets are met. |
To sum up, it’s been a long while since we saw this level of consensus among sell-side on an EM asset class. Judging by currency valuation metrics, the rally could still have legs before ‘crowded trade’ accusations snowball. For top regional picks and views on currency valuations and EM FX appreciation prospects, more generally, read elsewhere on EM.