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The USD is expected to not appreciate aggressively in the near term and therefore trouble EM currencies is because there is little tolerance for a much stronger USD among official actors.
A much stronger USD creates problems for China via capital outflows. It creates problems for EM commodity producers and it creates problems for the Fed in terms of imported deflation effects. Even if we see the USD appreciate more aggressively than investors currently expect we must assume the Fed will push-back as they did in March, Commerzbank reported.
Higher beta EM currencies broadly illustrate significantly improved external balances. Of the ’Fragile Five’, only Turkey stands out with a still large current account deficit. India, Indonesia, Brazil and South Africa all show large improvements with their respective deficits.
This makes these currencies less vulnerable to a US hiking cycle. Additionally, higher real rates mean that financing these deficits is more attractive than before. Carry to risk ratios are therefore more appealing for the likes of RUB, BRL, and IDR.
Indeed, given the perceived reaction function from the Fed this implies that volatilities are unlikely to surge towards higher levels as they did during previous phases of USD appreciation. If volatilities do increase, this will have more to do with idiosyncratic events rather than a change in trading regime.
Alternatively selling longer-dated upside calls in USD-RUB provides a good way of gaining premium and this is still a rewarding trade given the interest rate differential.
"Long positions in USD-TRY are recommended and we think a move towards 3.20 by year end is achievable," the report commented in itself.
