We note that the overall framework for the euro has turned negative vs. certain currencies (SEK and yen) based primarily on tactical factors and is less positive vs. the US dollar than before. The SEK, in particular, benefits from surging inflation, positive long-term fundamental drivers and a central bank that might have to reverse its accommodative stance, thereby supporting the currency.
Though rate differentials remain penalizing, the yen appears to be attractive based on our long term framework. In the current environment of geo-political uncertainty and the heavy dose of event risk present, the yen still remains an attractive safehaven and diversifying asset.
EMFX has rebounded since the beginning of the year on the back of solid EM growth momentum and more synchronized global growth extending to the Eurozone and Japan. We expect this trend to continue notwithstanding some volatility around monetary policy normalization and balance sheet unwinds in core markets like the US and the Eurozone. We hold a long EMFX position vs. the US Dollar, with overweights in cheap, commodity currencies like the Brazilian real (BRL), Colombian peso (COP), Indonesian rupiah (IDR), Malaysian ringgit (MYR), on expectation that these currencies will outperform due to their high real yields and relatively strong external positions. We also favour idiosyncratic currencies like the Mexican peso (MXN) based on lower probability of a disruptive NAFTA deal, credible Banxico policy management (introduction of a FX swap program, outstanding Fed swap line). Finally we remain overweight the Thai baht (THB) on strong external balance sheet dynamics and the Turkish lira (TRY) on attractive long term valuation and tight CB monetary policy.
These overweights are partially offset by a structural underweight in the Chinese yuan (CNH) and tactical underweights in the Colombian peso (COP) and South African rand (ZAR). The Chinese yuan (CNH) is expected to continue depreciating in the medium term due to the liberalization of the capital account and slower growth. The Colombian peso (COP) suffers from weak fundamentals (deteriorating twin balances) and the South African rand (ZAR) is negatively affected by downgrade risk, deteriorating fundamentals, weak policy mix with credible monetary policy and poor fiscal policy management.