FxWirePro: Mixed bag of propositions in EMFX trading baskets on lingering risks of US tariffs

The main risk to the FX outlook is that it depends on a gradual evolution of the economic cycle. The longer the US economy grows at the current rate (or a bit slower) without triggering a sharp pick-up in inflation, the more likely the Fed is to tighten slowly, and the less reason there is for the rest of the world to slow. The EMFX Outlook reflects this risk most clearly – as long as the US doesn’t slow too fast and the fed doesn’t tighten too fast, EM growth fundamentals will support emerging market currencies and the desire for carry will trump other concerns.

Fundamentals remain medium-term constructive EM FX but near-term complexities warrant trimming risks. Specifically, we reduce our EMFX conviction in the near term because:

1) The risks of further US tariffs and retaliation have increased, which could affect EM directly through trade or indirectly through prices.

2) EMFX positioning is high, specifically in LatAm and EM high-yielders, regions that tend to have larger commodity and external funding dependencies.

3) Neither EM valuations nor recent global fundamentals have marginally improved in the past few weeks to warrant risk adding.

We are neutral EM FX amid a more balanced short-term risk outlook

EMEA FX: We are MW in EMEA EMFX emphasizing RV plays. In CEE, we now have the highest conviction on our tactical short EURHUF trade added last week. Our conviction on short USDPLN has dropped, but we still believe the direction will be lower for the currency.

EM Asia FX: Neutral in the GBI-EM Model Portfolio but outright longs in SGD, KRW, and TWD, as EM Asia FX strength can play a part in mitigating trade tensions over the medium term.

Latin America FX: Maintain long JPYMXN and long USDCLP. Keep OW BRL and ARS, and UW MXN on medium-term considerations and UW PEN as a hedge.

In a standard carry trade, one takes advantage of a positive interest rate differential between two currencies. This position tends to perform in an environment of depressed volatility since the limited FX risk preserves the yield. However, the long high-yielding currency is almost always pretty volatile when it falls (think of emerging currencies), so the incremental carry profit can be destroyed in a wink if market sentiment deteriorates.

FxWirePro launches Absolute Return Managed Program. For more details, visit: 

http://www.fxwirepro.com/invest