By Tim Seymour
To answer the question posed in the headline: in short, yes and no. Emerging market currencies have undergone a massive re-rating over the last decade. In many cases, they are still undervalued on a purchasing power parity basis. Having said that, there are reasons why emerging market currencies have also undergone major volatility and even weakness in the last year. Look no further than economies that investors think are on a long-term path toward significant growth, such as Brazil and South Africa.
The Brazilian real has experienced major volatility. It depreciated from 1.70 to as high as 2.13 recently, as the government has aggressively cut rates and also worked to keep it weak.
Many emerging market countries are fearful of what they saw in 2007-08 when their export competitiveness was compromised by a rising currency, making their goods more expensive. Clearly, with emerging market FX, there is a short-term view and a long-term view.
In the long term, there are many that are on a path higher, especially those countries with solid domestic fundamentals that have the ability to fund themselves. The "generational trade" in emerging market FX is that these are solid fundamental credit and economic stories that offer a solid backdrop. That's why we own emerging markets overall.
To start the year, and in the short term, here are my thoughts.
Positive and Negative Factors:
- Fresh portfolio allocations into emerging markets by global real money investors at the start of the year are strong.
- Yen weakness boosting Japanese retail appetite for emerging market assets. Japanese and Asian investors are major players in the "carry trade" -- i.e., borrowing in local currency where money is cheap and investing in higher yielding assets.
- Rotational asset allocation shift within emerging markets, from credit to FX.
- Global cyclical recovery -- China and U.S. housing spur buying of resources and emerging markets. On the negative side, it’s been such a massive run into emerging markets over the last six weeks it’s time to take some profits. Technically we are overbought.
