Another Dollar Rally Awaits Emerging Markets

A cohort of Wall Street's emerging-market bulls is growing wary of calling a new dawn for riskier assets, opting for a more cautious approach to developing-nation currencies.

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With the bulk of Federal Reserve aggressive rate increases already over, some of the world's top investors predict the dollar will soon fall into a multi-year weakening trend. Such a shift stands to support emerging markets — and indeed propelled gains of nearly 9% in developing currencies from late October to early February. 

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But this month's market turmoil amid a greenback bounce has given pause to some would-be buyers.

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After the MSCI Inc. gauge of developing currencies nearly completely erased its year-to-date gains, money managers from abrdn Plc to Fidelity Investment are leery of being caught on the wrong side of the most recent dollar rise.

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James Athey, investment director of rates management at abrdn in London, said, "We are concerned tactically that EMFX has pushed too far too fast." "We fully foresee a US/global recession in the next six to twelve months," the Federal Reserve stated. "The Federal Reserve is not yet done raising."

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This uncertainty became abundantly clear on Friday as a surprise increase in the Fed's preferred price gauge lifted the currency and prospects of higher US rates for longer.

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The benchmark for currencies of developing nations saw declines worsened, causing it to reverse its year-to-gains gains on Monday. Indicator is currently on pace for its lowest month since September. A JPMorgan Chase & Co. measure of appetite for currency risk in emerging markets has also decreased this month after tipping negative for the first time this year in mid-February.

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The Thai baht has already lost all of its early-2023 gains, which were fueled by hope for a surge in Chinese tourists. And the rand, a measure of risk appetite frequently used in South Africa, has returned to levels last seen in late 2022.

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Abrdn had adopted a neutral view on the asset class before Friday's dollar rally, anticipating valuations to decline and reflect a recession. The dollar is now being purchased by investors at Fidelity International against the Filipino peso and the Polish zloty.

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In the meantime, the US rate-sensitive South African rand faces difficulties, according to Goldman Sachs Group Inc.

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Areas of Resistance

Nonetheless, given that several currencies from emerging economies have managed to endure the current surge of the dollar, there is still a reason for selection.

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The Mexican peso and Peruvian sol have so far defied the trend to advance versus the US dollar in February, supported by domestic inflation cycles and commodities.

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Paul Greer, a London-based money manager at Fidelity, stated that the LatAm block "appears to be significantly further along on the inflation and policy tightening cycle compared to other developing economies." Since the region now has very high ex-ante real yields, foreign portfolio inflows into the local bond and FX markets are encouraged.

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Several Asian currencies are also better positioned to weather a period of dollar strength, according to Alvin Tan, head of Asia FX strategy at RBC Capital Markets in Singapore, especially if an overly tight monetary policy sparks an economic slump in key economies.

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He said, "The Thai baht and the Korean won still seem to me to be fairly cheap." "I anticipate that regional assets and FX will continue to rise if Asia is able to escape a recession this year."