“The fact that emerging market currencies are cheap has been valid for the last several years, so in itself this is not a good reason to become more bullish on emerging market FX,” said Jaco Rouw, global foreign exchange investment manager at NN IP.
While both long-term valuation and short-term indicators like economic growth and Fed policy suggest there is more upside for emerging market currencies, there are also a few triggers that signal further upside in the near-term, noted Rouw.
“Importantly, emerging market growth momentum is improving, especially versus developed market growth momentum,” he said. In addition to that, the idea that a Fed hiking cycle would make it more difficult to fund current account deficits of emerging countries has become less relevant today, in Rouw’s view.
“Firstly, this is because the expectation of a Fed hiking cycle seems ‘so 2013/2014’. Indeed, the fact that the Fed is putting more emphasis on the link between Fed policy, the US dollar and risk appetite, and that they worry about the challenges related to persistently low natural real interest rates, all signal just a few rate hikes, instead of a hiking cycle,” he explained.
And, current account deficits of emerging countries have improved since 2013. According to the JP Morgan EMCI, emerging market currencies have appreciated close to 11% from the low in January this year.
10% more upside
The EMCI is even showing a reverse “head and shoulder” pattern, which is a typical reversal signal, highlighted Rouw, and said that if this is the case, breaking the neckline at around 70 indicates another 10% upside.
“This seems a lot but the EMCI index would then still be below the post-Lehman levels of early 2009, and just be back at the early 2003 levels, the start of the ‘commodity super cycle’,” he commented.
The so called ‘commodities super cycle’ included a sharp rise and fall of commodity prices between 2000 and 2014, following the Great Commodities Depression of the 1980s.
“The commodity super cycle is very unlikely to be repeated, mainly because Chinese economic growth has shifted to structurally lower levels. Still, the chart suggests there is plenty of upside for emerging market currencies. Most long-term fair value models do indeed indicate that emerging market currencies are still cheap.”