The overall framework – based on rate differential, carry-to-risk and economic surprises – is negative for the US dollar, which has seen some weakness in recent months. With the greenback continuing to weaken (notwithstanding the recent bounceback), the Euro has recently gained some appeal amongst foreign investors. With acceleration in the activity cycle, better macro-economic indicators and a central bank that looks set to taper its QE, the long Euro trade could still have legs. However, we aim to manage the exposure in a tactical manner as the trade remains vulnerable to central bank communications, especially with the uncertainty surrounding the Federal Reserve and the unease mentioned by some ECB board members after the recent appreciation of the common currency. Indeed a new hawkish Fed governor could initiate a re-pricing of market expectations and temporarily support the US Dollar.
Though rate differentials remain penalizing, the Yen – based on our long-term framework – appears attractive. In the current environment of geopolitical uncertainty and the heavy dose of event risk present, the Yen remains an attractive safe haven and a diversifying asset.
We remain constructive EMFX over the medium term, although we expect higher volatility into year-end. EMFX has rebounded YTD on solid EM growth momentum, attractive long-term valuations and a 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 have neutralized most of our EMFX over-weights. In Turkey, we maintain a small (1%) underweight position, given the deterioration in external balances, worsening inflation profile and the reluctance of the Central Bank to act decisively on stemming the currency and bond sell-off. In South Africa, although we acknowledge that the risk of a positive transition at the helm of the ANC has increased, we hold a 2% underweight given the lack of fiscal consolidation and that could lead to potential additional sovereign rating downgrades in November. Countries where we believe foreign investor positioning in the bond market is heavy (Indonesia, Russia) also run the risk of currency weakness should outflows materialize (we are small underweight on IDR and neutral on the RUB). Once the pricing-in of a higher risk of rate hikes in the US is completed, we believe the case for EMFX longs will resurface again (as commodity prices are up, growth is still solid and external balances healthy). On the IDR, Malaysian Ringgit (MYR), RUB and Peruvian Sol (PEN), we hold a medium-term constructive view. We are also looking to buy the Brazilian Real (BRL) and Mexican Peso (MXN) on dips.
These overweights are partially offset by a structural underweight in the Chinese Yuan (CNH). The CNH is expected to continue depreciating in the medium term due to the liberalization of its capital account and slower growth.