Don’t Fear the Fed, EM Currencies Can Do Well, Societe Generale

LAGOS (Capital Markets in Africa) – Emerging-market currencies should comfortably ride out coming Federal Reserve monetary tightening, according to Societe Generale SA.

The Fed’s slow and steady approach — expectations for hikes beyond Wednesday’s widely expected 25-basis-point move seem “extraordinarily subdued” — ensures that emerging market currencies will feel little impact, and carry trades will remain a viable strategy over the coming quarter, said Jason Daw, SocGen’s head of emerging-market foreign-exchange strategy in Singapore.

“EM currencies are following the script from 2004-2007,” Daw wrote in a note dated June 14. “This prior cycle taught us that currencies can perform well when central banks are slowly and methodically scaling back accommodative policies against a reflationary backdrop that is supported by favourable growth dynamics.”

The vast majority of emerging-market currencies have made solid advances against the dollar this year, led by the Mexican peso, which is up 15 percent, amid optimism for growth. Other gainers include the Polish zloty, Czech koruna, South African rand, Russian ruble and South Korea’s won. The Brazilian real is at the weaker end, falling 2 percent year-to-date as the country faced a corruption scandal.

SocGen particularly likes high yielders such as the Mexican peso, South African rand and Turkish lira, where consensus is bearish and investor interest remains modest. “These have the greatest potential to re-rate further alongside a constructive EM backdrop,” Daw wrote. On the other hand, the firm recommends avoiding the Brazilian real and Russian ruble at current levels given their positioning and domestic dynamics.

Even if the Fed delivers a hawkish surprise and causes markets to wobble, any sell-off in developing-nation currencies would provide an opportunity to buy the dip, Daw wrote. “Big surprises” that hurt risk assets aren’t Fed Chair Janet Yellen’s revealed preference though, according to the analysis.

“Eventually, cracks will start to form and the misallocation of capital from years of super-easy money may be exposed, whether through a classic recession or financial crisis, but this dynamic is likely to play out well beyond year end,” Daw wrote.