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Achieve more value in owning carry than shorting vols in EM: The paucity of opportunities to play vol compression is a boon for carry-friendly option bets in anticipation of a risk rally next week in the absence of an election upset. EM FX has depreciated against the dollar (CEE FX has outperformed in line with a higher EURUSD), as core yields have continued to move higher.
The external backdrop for EM FX will continue to be mixed through 2H’17. Notwithstanding broad USD depreciation against the EUR and the JPY, there could be temporary bouts of EM FX volatility as market participants focus on the paring back of extraordinarily accommodative monetary policies by major central banks.
We believe certain EM currencies could see more volatility in the coming months. Those that had received relatively more portfolio inflows since the US election could face downward pressure from profit-taking or FX hedging adjustments, namely the INR, IDR, KRW, and TWD. To be clear, however, EM currencies are in a healthier position than in 2013 when the 'taper tantrum' was in full swing.
In Asia, China's National Finance Work Conference suggests further RMB reform is on the cards. Also, we discuss the reasons behind USDIDR stability but see a modest rise towards year-end 2017. In addition, we believe the INR is sensitive to the more hawkish tones emanating from other major central banks and is exposed to a slowdown in portfolio inflows. Elsewhere, our Cyclical, Structural and Political FX framework suggests the KRW is unlikely to keep outperforming in 2H’17.
In CEEMEA, we believe the main counter force to TRY appreciation has been resident's FX purchases, which may change. Meanwhile, the RUB should stay supported from the central bank's relatively hawkish stance. It may face some depreciation pressure as the balance of payments tends to deteriorate during the coming months; however, this should be modest.
In LatAm, we have a stronger forecast for the MXN, but its pace of appreciation should slow going forward. We also outline our more optimistic view on the CLP as the economy's growth may have bottomed. Finally, we discuss the rationale for our revised USDCOP forecasts.
