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For the past few years, emerging market currencies have generally underperformed against the forwards. However, going forward, the weakness in spot rates would be mostly in line with positive carry.
Risks are somewhat asymmetric through to mid-2017 – slightly greater probability of EM currencies doing worse than the forwards.
There will be differentiation within EM - Asia is expected to underperform EMEA and LATAM, while by region, the best performers will likely be the RUB, INR, and BRL and the worst performers the ZAR, KRW, and CLP.
Selective carry trades that are backed by country-specific fundamentals are appropriate, but a wholesale return of passive carry trade strategies is not in the cards.
Over the next few months, two-way risks for EM FX will be more balanced, especially if Fed tightening expectations are pushed back further (although a severe deterioration in US growth prospects could have a negative feedback to EM).
During H2, there will be bouts of accelerated depreciation, periods of stabilization, and mini-rallies that will favour nimble tactical trading strategies. Oscillations in risk on/off trading should continue due to evolving expectations of Fed policy, Chinese, US, and EM growth prospects, and RMB depreciation.
Well, EM spot FX depreciation through to mid-2017 is expected to match the positive carry in the forward market. Asia will underperform EMEA and LATAM. Our top picks by region are the INR, BRL, and RUB while the KWR, ZAR, and CLP will underperform.
Recommendations – next 6-12 months
Regional: Short Asia against LATAM (BRL) and EMEA (RUB)
Long dollar exposure: Asia (KRW), EMEA (ZAR), LATAM (CLP)
Relative value: Short ZAR-RUB, short SGD-INR, short EUR-RUB, and short EUR-BRL.
