HSBC’s latest emerging markets (EMs) sentiment survey, published in January, suggested that investors became much more upbeat on EM currencies in the last quarter of 2020.
Various factors have contributed to this tilt towards long exposures, including higher commodity prices and improving economic activity globally.
However, while positive sentiment towards EM currencies is justified in the medium term, this is not necessarily the case in the near future due to a lack of visibility around vaccination programmes, not only in Latin America but also across Asia, suggests Daniel Tenengauzer, BNY Mellon Markets’ head of markets strategy.
Our long-term valuation models still point to EM FX being cheap against external drivers
Christian Wietoska, Deutsche Bank
While Deutsche Bank remains broadly constructive on EM currencies during 2021, it is turning tactically more cautious and expects the first quarter to be characterized by a higher degree of differentiation among currencies than the final three months of 2020, says Christian Wietoska, the head of the bank’s CEEMEA research team.
“Our long-term valuation models still point to EM FX being cheap against external drivers, but there is a valid question of whether these relationships have broken down in the short term,” he explains.
“Secondly, the return to normality will be highly uneven due to divergent vaccination timetables and, finally, the Georgia Senate run-off result has introduced a degree of risk for economies sensitive to US rate repricing.”
The picture becomes even more complex when drilling down to specific currencies.
Societe Generale is most bullish on the Turkish lira, the South African rand and the Egyptian pound, on the basis that Turkey and Egypt’s central banks will stay the course of maintaining elevated interest rates and preserving a sufficiently high real policy-rate buffer to encourage a return of portfolio flows and fight against dollarization.
In October, Euromoney reported that Turkey’s FX strategy was wreaking havoc on the lira. However, much has changed since then, with the country’s central bank regaining some much-needed credibility through a higher-than-expected increase in rates in December.
Deutsche now expects the Turkish central bank to keep a tight stance well into 2021, which should provide comfort for foreign investors.
The real is likely to underperform due to Brazil’s … deteriorating fiscal outlook
Phoenix Kalen, Societe Generale
At SocGen, EM strategist Phoenix Kalen reckons the Brazilian real and Mexican peso are likely to depreciate.
“The real is likely to underperform due to Brazil’s slow economic growth and a deteriorating fiscal outlook,” she says. “Meanwhile, the peso may depreciate due to the damaging economic impact of the second wave of the pandemic, as well as looser monetary policy and increasing political risk ahead of the mid-term elections.”
The Russian rouble might also be expected to encounter some volatility over the coming months on the expectation of a deterioration in US-Russia relations under a more hawkish Biden administration.
Deutsche’s Wietoska says: “Recent comments from the Biden team suggest the US will seek to cooperate with Russia over the strategic arms reduction treaty negotiations in January, though, and economic sanctions may not be first choice when it comes to retaliation.
“We would buy RUB and TRY versus the dollar or ZAR.”
Vaccine rollout
The Russian currency also continues to score well on other metrics, including the pace of the country’s vaccine rollout, the oil production output deal agreed with Opec in December, and seasonality, with gas exports driving improvement in the current account over the winter months.
Although acknowledging that the main beneficiaries from the vaccine are commodity currencies, Citi recommends giving the Brazilian real a wide berth due to fiscal risks in Brazil. But it also sees positive signs for the rouble and continued safety in Asia.
“Comparing countries where exports will bounce back the most in a reopening also adds Russia to the list of vaccine beneficiaries,” says Dirk Willer, Citi’s head of EM strategy. “While Asia will benefit the least from the vaccine bounce-back […] we don’t think there is major downside in Asia FX given strong fundamentals.”
The [Mexican] peso will outperform in the coming weeks while the real will likely underperform
Daniel Tenengauzer, BNY Mellon Markets
David Hauner, head of EM cross-asset strategy and economics at Bank of America, says the Mexican peso could be at risk of rating downgrades later in the year. The currency tends to be one of the more sensitive to rising US rates and a dovish central bank could exacerbate that weakness if Fed policy gets tighter.
BNY Mellon Markets is upbeat on the outlook for the real and the peso six to 12 months out.
“However, we do not believe current levels are the best to own all of these exposures,” says Tenengauzer. “We feel comfortable that the peso will outperform in the coming weeks while the real will likely underperform. We believe the real will remain unanchored until the Brazilian central bank begins a meaningful tightening cycle.”
The BNP Paribas EM strategy team likes the rand as an exposure to the Chinese recovery cycle and higher commodity prices. They see the real as one of the most attractively valued EM currencies and favour the peso as the best fiscal story in the region.
However, the rand is causing concern at Deutsche, according to Wietoska, who suggests that it now looks relatively expensive versus financial fair value and its basic balance. With the South African government caught between another March-style lockdown – which would be devastating for the economy, just as fiscal concerns are becoming acute – and a public health disaster, he recommends buying USD/ZAR.
“In contrast, the real is the cheapest currency in the world on financial and fundamental fair value and the Brazilian central bank is becoming more cautious about FX due to rising inflation,” he concludes.
