Why rallying emerging-market currencies could fall prey to a big unwind

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Some key emerging market currency pairs have held up better than maybe expected in the turmoil surrounding the return of stock-market volatility and rising fears of a global trade war. But there lies the worry for State Street Global Markets macro strategist John Velis, who fears the unwind could be painful when it does arrive.

“Given the increased volatility in developed markets, both in equities and bonds, it’s interesting that even though [we’ve seen] a general ‘risk off’ trend in the markets, EM assets have held up pretty well,” Velis told MarketWatch. “One would expect EM assets to be [in] the center of the storm.”

2018 has seen the return of stock-market volatility after a placid 2017. The most recent bout accompanied rising trade tensions between the U.S. and its major trade partners, particularly China. Stocks plunged then recovered in a wild Wednesday trading session after Beijing threatened retaliatory tariffs on $50 billion worth of U.S.-made goods on Wednesday.

While the U.S. dollar strengthened across the board against emerging market currencies on Thursday, the likes of the South African rand












USDZAR, -0.0409%










Korean won












USDKRW, +0.19%










the New Taiwan dollar












USDTWD, +0.0752%










 and Thai baht












USDTHB, +0.0000%










 are trading near their highest levels in years. But the higher you rally, the farther you can fall.

Volatility in emerging-market currencies and bonds has risen, but to a lesser degree than seen in developed markets, allowing EM assets to continue gaining ground, Velis said.

Among the reasons why the usually riskier emerging economies might be a good bet are higher bond yields that attract investors. “EM equities, chronic underperformers since the great financial crisis, finally started to outperform DM equities in the beginning of 2017 as portfolios began to shift into the relatively cheap asset—and one that offered stable growth,” Velis said.

Since then, EM performance has been impressive, Velis acknowledged. Global growth picked up last year, improving the outlook for emerging economies, as well as the developed world.

But multiple obstacles are in the way of continued happiness for EMs: “the rate cycle continues—albeit gradually—valuations are no longer at such a discount, and potential trade wars and vagaries of commodity price swings will present some challenges to the EM outlook,” Velis said.

Read: How tariffs aimed at China could ripple through emerging-market currencies

If investors started to unwind their EM positions rapidly, this could push those countries into a downward spiral. Herd behavior is something to look out for.

Still, not all emerging markets are created equal. Many currencies are driven more by their own idiosyncratic factors rather than overarching investor sentiment on emerging markets.

Turkey, for example, a popular EM play, saw the lira












USDTRY, -0.1036%










 fall to the lowest level on record against the U.S. dollar on Thursday. But this didn’t come out of nowhere, with a weak lira a trend that’s been almost one year in the making on weak economic fundamentals, a large budget deficit large, and a reliance on foreign capital.

Also check out: Brazilian real jumps on Lula ruling, but election uncertainty blurs currency’s outlook



Source : MTV