The overall framework – based on rate differential, carry-to-risk and economic surprises – is negative for the US dollar, which has seen some weakness over the past months. With the greenback continuing to weaken (notwithstanding the recent bounce back), 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 temporary support for 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, although with lower conviction. EMFX has rebounded YTD on solid EM growth momentum, attractive long-term valuations and more synchronized global growth, which has extended to the Eurozone and Japan. We expect this trend to continue, in spite of 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 Russian Ruble (RUB), the Chilean Peso (CLP), the Indonesian Rupiah (IDR) and the Malaysian Ringgit (MYR), on expectations that these currencies will outperform due to their high real yields and relatively strong external positions. Additionally, we hold a long position on the Peruvian Sol (PEN), based on the copper/commodity recovery theme. We are overweight the Brazilian Real (BRL), on expectations of stable risk-adjusted returns, limited political risks (as a centre-right candidate will most likely win the next presidency) and recovering growth. Finally, we hold a tactical overweight in the South African Rand (ZAR), given the rising expectations of a market-friendly ANC leadership transition.
These overweights are partially offset by a structural underweight in the Chinese Yuan (CNH), which is expected to continue depreciating in the medium term due to the liberalization of its capital account and slower growth.