The overall framework – based on rate differential, carry-to-risk and economic surprises – is negative for the US dollar, which has seen some weakness in recent months. Lately, the rhetoric of the US treasury department (specifically its head, Steven Mnuchin) has indicated that the weakness of the dollar was a positive for the US economy, and pushed the currency to even lower levels. With the greenback continuing to weaken, the Euro has recently gained some appeal amongst foreign investors. With acceleration in the activity cycle, better macro-economic indicators and a tapered QE programme, the long Euro trade could still have legs. However, we aim to manage the exposure in a tactical manner, as the trade remains vulnerable to Central Bank communications, especially with the uncertainty surrounding the Federal Reserve and the unease mentioned by some ECB board members after the recent appreciation of the common currency. Indeed a new, hawkish Fed governor could initiate a re-pricing of market expectations and temporarily support the US Dollar.
Though rate differentials remain penalizing, the Yen – based on our long-term framework – appears attractive. In the current environment of geopolitical uncertainty and the heavy dose of event-risk present, the Yen remains an attractive safe haven and a diversifying asset.
We remain constructive EMFX over the medium term. EMFX rebounded in 2017 on solid EM growth momentum, attractive long-term valuations and a more synchronized global growth extending to the Eurozone and Japan. We expect this trend to continue in 2018, notwithstanding some volatility around monetary policy normalization and balance-sheet unwinds in core markets like the US and the Eurozone.
Overall, we hold a tactical overweight (OW) position in EMFX on commodity exporters (BRL, CLP, PEN,) on expectations that they will outperform in a year of global growth recovery. We hold an overweight in IDR on the good carry to volatility and on the improvement in terms of trade. We also retain an OW in EGP (Egyptian pound) on a positive view on local rates and FX performance as the economy experiences adjustment.