Emerging currency bulls pay the price for ignoring risks

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Bloomberg

A cashier displays a collection of mixed denomination Turkish lira banknotes at a currency exchange in Istanbul. The lira was one of the emerging market currencies dragging down its peers in a rout last week. Photo: Bloomberg

It is less than a month into 2014 and currency strategists are already seeing their top trade recommendations for the year upended by the rout in emerging markets.

Buying Mexico’s peso versus the yen has lost about 1 percent since Bank of America named it as one of its top trades in November last year, with a 9.4 percent targeted return. Danske Bank exited a trade this month buying Turkey’s lira versus the Danish krone at a loss of 2.9 percent.

Of 31 major emerging market currencies, 13 have already weakened beyond their median year-end forecasts in Bloomberg analyst surveys.

“Traders either made their year or lost their jobs in the past week,” Douglas Borthwick, the head of foreign exchange at Chapdelaine in New York, said.

Exchange rates are tumbling across the developing world as a contraction in Chinese manufacturing adds to investors’ concerns about the impact of the US Federal Reserve’s tapering. Protests from Ukraine to Thailand are worsening the exodus, while Argentina’s unexpected devaluation of its peso last week dented confidence in Latin America.

“I didn’t see this escalation coming,” Benoit Anne, the head of emerging market strategy at Société Générale in London, said. “As a strategist, you want to give a directional view of the market, but this is made quite difficult by the large number of risk factors to account for.”

On January 16, Société Générale withdrew from a trade buying the rand versus Hungary’s forint, after losing 1.2 percent in just two weeks, Benoit said.

In abandoning their top picks, firms are reacting to the sharpest slump in emerging market currencies in five years. A Bloomberg index of the 20 most-traded exchange rates fell 1.2 percent last week, extending its decline over the past year to 9.4 percent, which is bigger than any annual slide since 2008.

More than a third of the most-traded emerging market currencies have already fallen below forecasts submitted to Bloomberg. At 2.3331 to the dollar yesterday morning in London, the Turkish lira is about 6 percent weaker than the median year-end prediction of 2.2 lira. Mexico’s peso is lower than Danske Bank’s forecast of 13.45 pesos to the dollar, the most bearish estimate of 41 strategists.

On November 24, Bank of America analysts recommended buying the Mexican peso as one of their top two Japanese-related trades for this year, predicting a rally that would have boosted the currency’s value to ¥8.4. Instead, the peso slumped 3.5 percent last week to ¥7.6022 in its biggest decline since August.

A Danske Bank strategist said on January 2 that the Danish bank had abandoned a trade to buy the lira versus the Danish krone, citing Turkey’s corruption scandal. Last month the bank labelled the trade as one of its 10 best ideas for this year.

“These currencies have fundamental challenges which we’ve been highlighting since the end of 2012,” said Thomas Stolper, the chief currency strategist in London for Goldman Sachs.

Morgan Stanley and UBS had also warned investors of the problems developing nation currencies were likely to face this year. Goldman Sachs recommended last month that its clients cut their emerging market holdings by a third to 6 percent.

Last week’s sell-off started with a report on Thursday saying that Chinese manufacturing might contract for the first time in six months. Hours later, Argentina’s peso started sliding as the central bank pared dollar sales to preserve international reserves, which have fallen to a seven-year low. The central bank said the next day it would lift currency controls, spurring the peso to a 15 percent weekly loss.

In Turkey, the central bank’s first unscheduled intervention in more than two years failed to stem the lira’s decline, caused by a corruption scandal and policymakers’ reluctance to raise interest rates.

While contagion from Argentina’s devaluation may be limited because foreign capital flowing into the country has averaged only about $1 billion (R11bn) in the past four years, the overspill from Turkey could become systemic, according to Citigroup, the second-largest currency trader.

The lira fell 4.4 percent against the dollar last week and touched a record low on Friday of 2.3448 to the dollar and 3.2069 to the euro. The lira was little changed versus both currencies yesterday.

Last week the rand fell beyond R11 to the dollar for the first time since 2008 amid concern that a platinum sector strike will dent exports. Other commodity exporters’ currencies, including the Brazilian real, Chilean peso and Russian rouble, also fell on expectations that demand from China would dry up.

“Argentina, Turkey and South Africa led other markets sharply lower in what has the potential to be the most troublesome emerging market-led correction since 1998,” Michael Shaoul, the chief executive of Marketfield Asset Management, wrote in a client note.

Last week’s declines in the rand and lira were more than two-and-a-half times their normal trading ranges, which statistically occurs about 3 percent of the time, according to data compiled by Bloomberg.

JPMorgan Chase’s emerging market volatility index, which measures expectations of price swings, jumped to 9.8 percent on Friday, from 8.6 percent a week earlier.

Even so, declines like last week’s are not so unusual in emerging market foreign exchange. Bloomberg’s currencies index is down 2.7 percent over the past month, compared with a 3.7 percent drop in May last year, when the Fed signalled it could pare its bond purchases. The gauge fell 2.4 percent last August on speculation tapering was about to start.

The current slump coincides with concerns the Fed will quicken the pace of withdrawal at its meeting today and tomorrow.

Thomas Kressin, the head of European foreign exchange at Pacific Investment Management in Munich, said that once the initial rout was over, currencies would recover as investors picked winners and losers. “It’s a stampede at the moment, so investors didn’t differentiate between quality names and low quality,” Kressin said. “Once the risk aversion abates, I think people will start to differentiate again.”

Others say the declines are sowing the seeds of problems for developing nations.

Weaker currencies would push up overseas debt payments for countries, damping the outlook for their economies, Rashique Rahman, the New York-based co-head of foreign exchange and emerging market strategy at Morgan Stanley, said.

“With currency weakness being primarily led by capital outflows, the associated weakness in growth could lead to a reassessment of fiscal health,” Rahman said. “This, in our view, is the next stage in the cycle for emerging markets.” – Bloomberg


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