David Kohl, chief currency strategist at Julius Baer, explains why the firm has revised its views on EM currencies.
The uncertainty created by the depreciation of the renminbi last week is spreading into other emerging markets, putting pressure on their respective currency.
We have reviewed our currency forecast and adjusted them along the following lines:
The major currencies EUR and JPY are 2-3 standard deviations undervalued against the USD according to our calculation. Most emerging markets are not that cheap. We expect this distortion to correct in the coming months.
As a result, we are revising our view on the Turkish lira and the Indian rupee down from bullish to neutral. An even more negative currency outlook is challenged by the considerable interest-rate carry that both currencies are presently offering to the investors.
Furthermore, we are revising our outlook for the RUB and the ZAR from neutral to bearish as the RUB is, along with the BRL and IDR, the most expensive emerging market currency and the ZAR offers only a modest carry to compensate for its risks.
The ranking for the BRL and the IDR remain bearish. Safe-haven currencies like the USD and the CHF should profit from this development and also the JPY and EUR, which had been used as carry-trade financing vehicles to receive support from short-covering.
Only a few emerging market currencies remain attractive, among them a deeply undervalued MXN and emerging market currencies from eastern Europe like the PLN and the HUF, which are cheap and have rebalanced their economies two years ago.
With the most recent stabilisation efforts of the People’s Bank of China we are revising our three-month forecast to 6.6 USD/CNY but maintain a bearish view for the currency.
Most emerging market currencies have more downside potential given that they are much less undervalued than the EUR and the JPY and seem to have much worse currency fundamentals.