Emerging Currencies Can Weather the Coming Rate-Rise Storm

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JULY 17, 2017 – As global bonds reel under hawkish rhetoric by major central bankers, AllianceBernstein and Amundi Asset Management say emerging-market currencies will weather the storm better than 2013.

Improvements in external balances, higher reserves and subdued inflation are among factors making developing-nation economies from India to Mexico appear less vulnerable to the risk of outflows when their advanced peers begin to taper, they say. Recent stability in exchange rates and a gauge of price swings near a three-year low are signs of their resilience.

“This episode of rising developed-market yields is unlikely to be as negative as it was in the 2013 taper tantrum selloff,” said Abbas Ameli-Renani, a London-based portfolio manager for EM bonds and currencies at Amundi, which oversees $1.2 trillion. “We continue to be comfortable with currency exposure on higher yielding EM currencies with ongoing external rebalancing, such as the Mexican peso and Brazilian real.”

Central banks led by the U.S. Federal Reserve are preparing to roll back easy credit policies as their economies recover and borrowing costs rise. Canada raised rates last week for the first time since 2010, becoming the first Group of Seven country to join the U.S. in doing so, while the European Central Bank and the Bank of England have hinted at the need to tighten.

The phasing out of stimulus is an unprecedented challenge that may be more disruptive than people think, JPMorgan Chase & Co. Chairman Jamie Dimon said Tuesday. The ECB’s Governing Council is scheduled to meet in Frankfurt July 19-20, with respondents in a Bloomberg survey split on whether officials might set the tone by dropping a pledge to boost quantitative easing if needed.

Even so, the MSCI Emerging Markets Currency Index is up in July, and higher from a month earlier, when the Bank of Canada surprised investors with a strong signal that it’s ready to raise rates. The J.P. Morgan Emerging Market Volatility Index fell last week, reversing a two-week advance, and still trades near its lowest level since 2014.

Further, the case for dollar bears is growing stronger as weaker-than-forecast economic data raises doubts about the prospect of additional Fed tightening this year. The greenback sank to a 10-month low Friday, rounding out its worst week since May, after a consumer price index report that showed continued weak pricing power in June across a range of goods and services.

Emerging-market currencies have been a bright spot for investors amid a global hunt for yields. Higher rates have attracted inflows from overseas, helping improve the nations’ external balances. Slowing inflation has added to the appeal of many of these markets, while governments in India and Indonesia have taken steps to boost the economy.

HSBC Holdings Plc says it is bullish on local-currency government bonds in Mexico, South Africa, India, Indonesia, Malaysia and Russia, citing an expected decline in inflation risk premiums that will likely trigger flatter yield curves. Asian currencies topped a recent Bloomberg survey of EM watchers for their resilience to the risks looming ahead.

“What’s really different today is that EM vulnerability is more concentrated in a narrow set of countries that do not constitute large parts of major equity or debt indexes,” said Morgan Harting, a New-York based portfolio manager at AllianceBernstein. Brazil, Turkey, Indonesia, India and Thailand, which were among the worst affected during the taper tantrum in 2013, have improved their fundamentals, he said.

A growing stockpile of foreign-exchange reserves has left developing nations with “greater firepower” than four years ago to absorb global shocks, giving investors “greater confidence in the macro stability of an EM country or region,” said Viraj Patel, a London-based foreign-exchange strategist at ING Groep NV.

Even so, money managers and strategists don’t expect emerging-market assets to be completely insulated when central banks begin to tighten. Also, their recommendations below explain why they are more optimistic about certain markets than others.

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