CEEMEA FX best performer in first quarter; opportunities remain in TRY and RUB

Year to date, the main CEEMEA currencies outperformed other EM regions by a large margin after the sell-off at the end of 2011. CEEMEA currencies were up by 8.2% on a total return basis versus the USD, compared with 7.0% in Latam and 2.6% in Asia. CEEMEA currencies have also been among the top performers when comparing risk-adjusted returns. Four out of the five currencies with the highest Sharpe ratios in the first quarter of 2012 have been from CEEMEA.

Positive developments in Europe, particularly with the perceived success of the long-term refinancing operation, have been the primary driver behind outperformance of these currencies, says Wike Groenenberg, Citi’s head of CEEMEA currency strategy. The high-yielding currencies have also benefited from attractive levels of carry, of over 400 basis points. Citi says that while the first quarter’s impressive performance of CEEMEA currencies is unlikely to be matched to the same extent in the next quarter, opportunities in TRY and RUB continue to exist.

The Turkish central bank has, in effect, become a currency targeter – with an informal trading band for USDTRY between TL1.70 and TL1.80, explains Groenenberg.

“When TRY trades close to or outside these ranges, it has been attractive to take a position,” says Groenenberg. “This is particularly so after the central bank has adjusted interest rates up or down in an effort to push the currency back into range.”

Ali Yigitbasioglu, CEE portfolio manager at the Cambridge Strategy, says the actions of the central bank have become a key consideration when trading the Turkish lira.

“The Turkish central bank is likely to be more worried about disorderly lira weakness, given weak current account and a high inflationary pass-through in rising oil prices, says Yigitbasioglu. “If USDTRY goes to 1.82-1.83, then I’d sell USDTRY.”

Yigitbasioglu, however, warns that the Turkish lira is hampered by the non-negligible tail risk of involvement in Syria.

“It’s not my base case but there is a degree of complacency surrounding the pressure that’s building up across the border and it would take very little for the spark to be lit,” says Yigitbasioglu.

Investors should be mindful of the risk that, in such a scenario, the oil price would spike and TRY would be sold off in a kneejerk fashion.

With regards to the Russian rouble, Citi views a continuation of high oil prices as a predominant force underpinning high currency inflows and RUB strength. The current account surplus of more than $100 billion this year is estimated to exceed likely capital account outflows.

While real effective exchange rates (REER) analysis shows that the RUB has been steadily appreciating in real terms to well above its long-term average, Citi says this alone should not put off investors taking bullish RUB positions.

“Such mis-valuations are common and persistent in currencies where commodities are the main source of export revenues,” notes Groenenberg. Aside from oil, the rouble could also benefit from Russia becoming a fundamentally less risky proposition.

“A degree of political uncertainty has been removed now that elections are out of the way and real GDP growth rates in Russia are looking to be among the best in the region,” notes Yigitbasioglu.