FxWirePro: Shorts in TRY and SAR among EMFX space stand out as bearish streaks likely to prolong in 2017 owing to Fed hiking cycle and Trump presidency

The dollar in the recent times has been gaining traction for upward targets against majors (the strengthening dollar sentiments likely to continue in Q1’2017) on account of three fundamental factors: OPEC’s production cuts, Trumps’ robust fiscal policy framework and upbeat economic numbers in the US (and Fed rate hikes is an extra impetus).

In contrast, the foreign investors’ and FX market sentiment was devastatingly negative towards EM coming into 2016. The overflowing of the commodity bubble, the enormous glut in the oil market and the Chinese growth slowdown all weighed on EM growth.

The currencies in EMFX have been declining dramatically in January and February before the Fed came with a reprieve in March and June. US growth and inflation forecasts declined modestly and most importantly, the Fed’s famous dot plot had significant downward revisions.

When we came into 2016 the Fed projected 4 rate hikes and a similar number of hikes in 2017. At the time of writing consensus expectations are for a rate hike in December followed by two rate hikes in 2017.

EM currencies rallied and both hard and local currency bonds outperformed. This performance was helped by the growth stabilization in China. Chinese growth held up better than expected and the property market showed some signs of stabilization, which decreased the chances of a ‘hard landing’.

We expect better EM aggregate growth in 2017; EM as a whole should illustrate growth prints in the region of 4.6%. Inflation prints should remain relatively subdued and where we see increasing inflation prints these will be largely a reflection of FX pass-through effects.

EM real rates are higher than before and external balances show significant improvements. Those EM’s with the poorest real rate – balance of payments metrics can expect the most severe FX depreciations. TRY and SAR stand out in this regard. In rates space, we think that hard currency bonds will underperform until the market has fully digested the combination of the Fed’s rate hiking cycle and the implications of the Trump presidency

As we already carry bullish stance on USDTRY since late October, still encourage longs in USDTRY via option contracts on hedging grounds. Among EMEA currencies, we reckon TRY has the most potential to drift below. While Turkish central bank surprised the market with a rate hike in November but they are reluctant to raise rates enough to stabilize the lira. We expect a move towards 3.80 over the course of the year.

Long USDSAR: We recommended this trade last year more in hope than expectation but the opportunity cost of the trade was tiny compared to the potential pay-off and we are content to recommend the trade once more. The peg is only sustainable as long as oil prices are around 75 USD per barrel and any increased capital flight / reserve drawdowns will make the situation more untenable.