ANALYSIS: Weaker dollar improves EM/Frontier FX fair values


By Robertson Charles

FRI, JANUARY 5 2018-theG&BJournal- I can only begin to imagine how stressful it must be for European buy-side clients right now trying to stop the sell-side sending you stuff.  Anyway Happy New Year.

If we needed a peg for this piece, Angola – with the most overvalued currency in our universe – has provided it.  The CB wants to re-peg the currency at a more realistic rate, with currency bands.  The official rate is around 166/$ and the parallel market rate is 430/$ according to Bloomberg.  Using our 1995-2017 REER model – updated this week – we think fair value is 348/$, so the black market rate has overshot just like Nigeria’s did when it hit NGN520/$ in Feb-2017.

Elsewhere we still like Nigeria even if fair value of the currency has slipped from around NGN360/$ in 2Q17 to NGN385/$ now.  It may be 7% overvalued, but the C/A is in surplus and local yields for one year are 16%.

Egypt still looks better, with a 16% undervalued currency, a C/A largely covered by FDI, and interest rates before tax of 18%.

Ghana also is still interesting with 15% undervaluation, an improved C/A deficit and 15% yields for one year.

Turkey too – but only for FICC investors with a one-year horizon, not a one-month horizon.  The equity market still seems too expensive given where local bond yields are.

Colombia is apparently 39% undervalued – by far the cheapest in EM. 

Tunisia is the cheapest in Frontier – I’m due to be there on 15-17th Jan to find out more – you’re welcome to join.

Other questions put to us this week is what will happen to Morocco – not much even if they do belatedly widen the currency bands by a few percent.

South Africa – we’re suggesting 12-13/$ unless Ramaphosa displaces Zuma already this year (in which case it may move stronger than the new fair value of ZAR11.7$) – with a weakening risk depending on the dollar’s move globally, commodity prices and a possible debt rating downgrade.

We’re OK with Russia – and a little bit interested in very cheap (25% undervalued) Ukraine and super-cheap (34% undervalued) Belarus.

The weaker dollar has made nearly all EM/Frontier currencies appear to be better value. We still like the Egyptian pound, the Nigerian naira and Ghanaian cedi, and see Turkish lira value over one year. In our view, the Tunisian dinar is particularly cheap in Frontier.

EM’s expensive currencies have decent current account positions, cheap currencies look interesting

As the US dollar has weakened since March, our estimates of EM fair value (derived from the 21 December update of Real Effective Exchange Rate [REER] data from the Bruegel Group) have mostly improved. Most EM currencies look less overvalued (mostly Asia) or cheaper than we might have expected even after a rally (the rand). Some of the biggest shifts include Pakistan, now just 13% overvalued and in line with Sri Lanka. It’s still expensive but less of a deterrent to investing there than it was. Russia is 12% expensive, but supported by a current account (C/A) surplus. We assume the rand stays roughly 5% cheap to ZAR11.7/$ fair value, unless ANC leader Cyril Ramaphosa becomes SA president in 2018. We still like the Egyptian pound, on the assumption of no currency movement until end-2019, when we forecast its fair value will have depreciated to EGP18.0/$. The other attractive currency based on data since 1995 is Turkey, which when it is this cheap has always delivered a positive nominal return over the subsequent year. Lastly, we have to mention Colombia, despite it being outside our normal coverage. At 39% cheap we think the Colombian peso is a standout in EM, particularly with oil prices in the $60-70/bl range.

Frontier – still liking the naira and Tunisian dinar too, Argentina’s overvaluation hard to judge

Among Frontier currencies we are still comfortable recommending naira, given it is only 7% overvalued (fair value has slipped to NGN385/$ on our 1995-2017 REER model). The C/A surplus and double-digit yields mean even further depreciation of ‘fair value’ to NGN415/$ by end-2018 would still leave the currency at NGN360/$, at an unremarkable 15% overvalued level. Kazakhstan looks cheap, but our economist Oleg Kouzmin is expecting gentle depreciation to KZT345/$ (assuming $55/bl oil). It is Tunisia which has captured our attention. The large C/A deficit has helped drive the Tunisian dinar to a 25% undervaluation relative to its long-term history, and this scale of undervaluation has been rare (3% of the time) since 1995. We are scheduled to visit Tunisia on 15-17 January.

We see no reason to worry about the apparently overvalued Vietnamese dong and Bangladeshi taka, given their good C/A positions. We see some depreciation risk in Romania vs the euro. Argentina is a tougher call. The Argentine peso is 63% overvalued based on our calculations but this may be significantly overstated. In addition, we are overweight the equities and see why FICC investors would buy the high yield, so portfolio inflows may keep it strong. We think the C/A deficit implies much less overvaluation than 63%, and that even 15% nominal currency depreciation would still give a reasonable 10% dollar return to local fixed income investors. Kenya remains hard to judge in our view, like many Frontier currencies.

Africa and beyond Frontier – there is value in local currency bonds across Africa and CIS

Ghana, Egypt and Tunisia are the cheapest three currencies that we follow in Africa, and Belarus and Ukraine appear to offer value in the CIS. Central Africa and Angola look expensive. North Africa ranges from a little undervalued to very cheap.

The dollar and commodities remain key variables

The best news for EM FX is further dollar weakness. Commodities are another key variable that appear to be supported by the strength of the global economy. We see room for decent returns in EM and Frontier local currency.

If you have any questions or comments regarding this report, please contact Charles Robertson or Vikram Lopez.

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