Emerging currencies still offer appealing returns but dollar strength will limit upside in short term.
For choice, go for the cheapest – undervalued currencies are likely to recover versus the dollar in H2.
Flexible – up to a point
"Chinese authorities have introduced more flexibility but want to remain in control"
Yuan – more volatile. Continuing a recent streak of financial reforms, China has moved to a more flexible currency policy, leading to more yuan volatility versus the dollar. The Chinese currency gained 6% between May and early September, triggering capital outflows but also giving the lie to Donald Trump’s allegations of currency manipulation, before shedding 2.5% these last few weeks. However, it should be remembered that the yuan is no longer supposed to be pegged to the greenback but rather to a trade-weighted currency basket. From this angle, the yuan has remained rather stable. Looking forward, we expect the currency to soften somewhat – 1) the dollar will be supported by US rate hike expectations; 2) short CNY positions are set to decline; and 3) the boom in corporate borrowing will require deeper financial reforms and a weaker currency could help limit the damage. However, this is a double edged sword, as retail investors are overly sensitive to the USD/CNY rate and capital outflows are a drain on domestic liquidity. As a result, Chinese authorities will want to remain in control to avoid excessive volatility – we expect USD/CNY to hover around 6.70 in six and twelve months.
"Emerging currencies will continue to offer positive returns."
Emerging currencies – good returns despite US rate hikes. Most emerging currencies have gained ground against the dollar year-to-date. They have been supported by their attractive yields and some improvement in current accounts, although the greenback has recovered recently on the back of revived hopes of US rate hikes and fiscal reforms. While some weakness cannot be ruled out in the short run, emerging currencies will remain buoyed by stronger growth than in developed economies. Carry is likely to remain attractive as central banks will not cut rates too quickly despite lower inflation. These factors are set to drive emerging currencies a little higher, albeit from low levels. In particular, we would focus on some of the cheapest EM currencies, given our expectations for further economic improvement and low political risks.
Sources: SGPB, Bloomberg, 05/10/2017. Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.