FxWirePro: Fair assessment of EMFX hedging dimensions

Emerging market currencies are set to remain challenged by the risk of an escalating trade war, lower commodity prices and a stronger USD near-term and rising US rates and tighter US liquidity over the medium term.

Notably, TRY has suffered driven by political developments but otherwise, we see the risk of a contagious sell-off as limited, as the likelihood of significant further USD strength is small after all. With the ECB effectively on hold and wage-price pressure mounting in, notably, Eastern Europe, these currencies, in particular, should stay supported vis-à-vis the EUR near term.

We recommend relative value positions while avoiding exposure to global trade tensions. We continue to see some signs that EM FX risk appetite can recover, however, risks and vulnerabilities remain very high, with trade tensions and geopolitics at the centre of our concerns.

We are therefore cautious in our own portfolio, staying MW and focusing on picking currencies that can recover while holding on to FX hedges that should perform well on an escalation in global growth risks and trade tensions.

RUB: The Russian ruble continues its journey detached from the crude price, driven mostly by the global emerging market sentiment on the trade war and geopolitical cautiousness; notably, Russia’s Ministry of Finance is set to continue limiting the RUB’s extra strengthening on oil price swings. Still, a lower oil price would be RUB negative. The revived hawkishness of the Bank of Russia is helping the RUB among other emerging markets. Given the current escalation of global trade wars, we see the USDRUB pair staying higher from our previous forecasts but lower still over the forecast horizon: 61.70 in 1M (previously 61.50), 60.90 in 3M (previously 60.10), 59.00 in 6M (previously 58.30) and 57.50 in 12M (previously 55.70).

TRY: The market had expected a rate hike of approx. 100bp from the Turkish central bank yesterday. It is therefore hardly surprising that the inactivity of the Turkish central bankers put considerable pressure on the Turkish lira.

The Central Bank of Turkey unexpectedly held its benchmark interest rate at 17.75 percent on July 24th following a 125bps hike last month to support the lira, which already lost around 20 percent of its value so far this year. The projections were pointing to an increase of 100-125bps after inflation jumped in June to its highest level in 14 years.

The Turkish lira has entered another perfect storm, as shaky macro fundamentals are eroded by the high oil price, weak emerging market sentiment and the returning personal grip of President Recep Erdogan on the economic processes, TRY and monetary policy. The markets continue to dislike this kind of interference, now pricing extremely high TRY hedging. Courtesy: JPM, Danske