December 6, 2021

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FX Traders Seek Emerging-Market Gems Amid the Wreckage of 2021

(Bloomberg) — Emerging-market currency traders will have to pick their fights carefully for the coming year after a surprisingly strong dollar and rising U.S. Treasury yields steamrolled almost everything in the developing world in 2021.

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With investors ramping up expectations for the Federal Reserve and other developed-market central banks to tighten policy, the likes of the Brazilian real and Hungarian forint have been weighed down by inflation and political concerns even as local officials pushed up borrowing costs. The Chinese yuan and Taiwanese dollar have been among the few to stand their ground.

Some currencies may have been punished too much though, and the prospect of a shift in global dynamics may prompt investors to dip their toes back in, even if the outlook for emerging markets as a whole remains uncertain. Barclays Plc is advising clients to bet on the Brazilian, Russian, Mexican and South Korean currencies. Discovery Capital Management, the $2.4 billion hedge fund, is more focused on opportunities in eastern Europe, like the forint.

“We expect increased differentiation in EM assets as the expansion matures, China slows, and extraordinary stimulus fades,” Barclays analysts including Christian Keller wrote in a note to clients last week. “Most EM central banks are leading DMs in the normalization cycle and generous EM risk premia should attract some flows, but structural factors such as certain commodity exposures should also guide asset selection.”

TD Securities reckons forward markets are pricing in too much weakness for a number of currencies such as the real, the Indonesian rupiah and the South African rand, and have recommended a basket trade including these and others.

“With yields adjusting higher, and FX weakening, it is possible that emerging markets will sit better positioned for an eventual Fed rate hike,” TD strategists including Sacha Tihanyi wrote in a report last week. “However, the vulnerability of each EM economy will be important to consider within the context of potential further pressure in 2022.”

From a funding perspective, Latin America appears to be the region most at risk, according to TD, while the outlook for Asia is stronger. That said, strategists see a potential opportunity in Brazil, which is currently being hampered by political uncertainty ahead of elections next year. While there are plenty of risks and potential volatility, they predict the real may restrengthen to the 5 per dollar level, from about 5.584 in early Monday trading.

Discovery Capital founder Rob Citrone is more circumspect about the prospects for Brazil and Russia. While he sees potential for the real to eventually gain after the noise of the Brazilian election campaign clears, the currency will likely be on the weaker side and markets will remain nervous ahead of the vote. While Russia has seen its currency buoyed by a combination of higher energy prices and rate hikes — and some observers continue to label it as cheap — Citrone says it isn’t worth the geopolitical risk and uncertainty.

For his part, bets on the Hungarian, Czech and Polish currencies against the euro offer the best risk-reward. All three nations have seen central-bank rate hikes and “we think there’s probably some more to go because inflation is higher,” Citrone said. “Despite the rate hikes, the growth prospects for these countries remains much higher. We think all their currencies are incredibly competitive,” he said in an interview.

Here are some of the major events and data to look out for this week:

  • Traders are monitoring Chilean markets as conservative presidential candidate Jose Antonio Kast and leftist rival Gabriel Boric head into a runoff in the nation’s most divisive election since the return of democracy in 1990

  • South Korea’s monetary authority is forecast to increase its key rate on Thursday, though investor focus will be more on any clues about the timing of the next hike

  • Nigeria’s central bank is set on Tuesday to keep interest rates on hold

  • In Mexico, inflation data for the first half of November to be released on Wednesday will probably extend a trend upward, while Bloomberg Economics expects revised third-quarter gross-domestic product figures on Thursday to show a bigger quarter-on-quarter decline than in preliminary numbers

  • Data may show that inflation in both Malaysia and Singapore rose in October. Singapore will also release final third-quarter GDP numbers on Tuesday

(Updates with currency pricing, Chile market action.)

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