Top Trades in Disarray Amidst Emerging-Market Rout: Currencies

Jan 27, 2014 3:58 am ET

(For a Currencies column daily alert: SALT FXCOL.)

Jan. 27 (Bloomberg) -- It’s less than a month into 2014 and already currency strategists are seeing their top trade recommendations for the year upended by the rout in emerging markets.

Buying Mexico’s peso versus the yen has lost about 1 percent since Bank of America Corp. named the trade one of its top picks in November, with a targeted return of 9.4 percent. Danske Bank A/S exited a trade this month buying Turkey’s lira versus Denmark’s krone at a loss of 2.9 percent. Of 31 major emerging-market currencies, 13 have already weakened beyond their median year-end forecasts in Bloomberg analyst surveys.

“Traders either made their year or lost their jobs in the last week,” Douglas Borthwick, the head of foreign exchange at Chapdelaine & Co. in New York, said by phone Jan. 24.

Exchange rates are tumbling to records across the developing world as a contraction in Chinese manufacturing adds to investors’ concern about the impact of the Federal Reserve withdrawing its unprecedented monetary stimulus. Deadly protests from Ukraine to Thailand are worsening the exodus, while Argentina’s unexpected devaluation of its peso last week dented confidence in Latin America.

‘Risk Factors’

“I didn’t see this escalation coming,” Benoit Anne, the head of emerging-market strategy at Societe Generale SA in London, said by phone Jan. 24. “As a strategist, you want to give a directional view of the market, but this is made quite difficult by the large number of risk factors to account for.”

SocGen withdrew Jan. 16 from a trade buying South Africa’s rand versus Hungary’s forint, after losing 1.2 percent in just two weeks, Benoit said.

In abandoning their top picks, firms are reacting to the sharpest slump in emerging-market currencies in five years. A Bloomberg index of the 20 most-traded exchange rates fell 1.2 percent last week, extending its decline over the past year to 9.4 percent, bigger than any annual slide since 2008.

More than a third of the most-traded emerging-market currencies have already fallen below forecasts submitted to Bloomberg. At 2.3365 per dollar last week, the lira was about 6 percent weaker than the median year-end prediction of 2.2, while Mexico’s peso was lower than Danske Bank A/S’s forecast of 13.45, the most bearish estimate of 41 strategists.

Japan Trades

Bank of America analysts recommended buying the Mexican peso on Nov. 24 as one of their top two Japan-related trades for this year, predicting a rally that would have boosted the currency’s value to 8.4 yen. Instead, the peso slumped 3.5 percent last week to 7.6022 yen in its biggest decline since August. Rinat Rond, a spokeswoman for the lender in New York, declined to comment.

A Danske Bank strategist said Jan. 2 they’d abandoned a trade to buy the lira versus the Danish krone, citing Turkey’s corruption scandal. Last month, the analyst labeled the trade one of their 10 best ideas for 2014.

The slump has been “fun to watch,” Thomas Stolper, the chief currency strategist in London at Goldman Sachs Group Inc., said by phone Jan. 24. “These currencies have fundamental challenges which we’ve been highlighting since the end of 2012.”

Morgan Stanley and UBS AG had also warned investors of the problems developing-nation currencies were likely to face this year. Goldman recommended in December that its clients cut their emerging-market holdings by a third to 6 percent.

China’s Impact

Last week’s selloff started with a Jan. 23 report from HSBC Holdings Plc and Markit Economics Ltd. saying Chinese manufacturing may contract for the first time in six months. This added to concern that growth in the Asian nation, which buys everything from Chile’s copper to South Korea’s cars, is losing momentum.

Hours later, Argentina’s peso started sliding as the central bank pared dollar sales to preserve international reserves that have fallen to a seven-year low. The central bank said the next day it would lift currency controls, spurring the peso to a 15 percent weekly loss.

In Turkey, the central bank’s first unscheduled intervention in more than two years failed to stem the lira’s decline, caused by policy makers’ reluctance to raise interest rates and a corruption scandal embroiling Prime Minister Recep Tayyip Erdogan’s cabinet.

Systemic Risk

While contagion from Argentina’s devaluation may be limited because foreign capital flowing into the country has averaged only about $1 billion in the past four years, the overspill from Turkey could become systemic, according to Citigroup Inc., the second-largest currency trader.

The lira fell 4.4 percent against the U.S. currency last week, the most since May 2010, and touched all-time lows on Jan. 24 of 2.3448 to the dollar and 3.2069 per euro.

South Africa’s rand dropped beyond 11 per dollar for the first time since 2008, reaching 11.1949 on Jan. 24 amid concern a strike at the world’s biggest platinum mines will dent exports. Other commodity exporters’ currencies, including the Brazilian real, Chilean peso and Russian ruble, also fell on bets demand from China will dry up.

“Argentina, Turkey and South Africa led other markets sharply lower in what has the potential to be the most troublesome EM-led correction since 1998,” Michael Shaoul, the New York-based chairman and chief executive officer of Marketfield Asset Management LLC, which oversees $21 billion, wrote in a Jan. 24 client note.

Unusual Times?

Last week’s declines in the rand and lira were more than 2 1/2 times their normal trading ranges, which statistically occurs about 3 percent of the time, according to data compiled by Bloomberg. JPMorgan Chase & Co.’s Emerging-Market Volatility Index, which measures investor expectations of price swings, jumped to 9.8 percent on Jan. 24, from 8.6 percent a week earlier, the biggest increase since June.

Even so, declines like last week’s aren’t so unusual in emerging-market foreign exchange.

Bloomberg’s currencies index is down 2.6 percent over the past month, compared with a 3.7 percent drop in May, when the Fed signaled it could pare the bond purchases that have helped fuel global investment.

The gauge fell 2.4 percent in August on speculation tapering was about to start. The current slump coincides with concerns the Fed will quicken the pace of withdrawal at its Jan. 28-29 meeting, after it finally confirmed in December that bond purchases would be cut from $85 billion starting this month.

Picking Winners

Thomas Kressin, the head of European foreign-exchange at Pacific Investment Management Co. in Munich, said that once the initial rout is over, currencies including the Mexican peso will recover as investors pick winners and losers.

“It’s a stampede at the moment, so investors didn’t differentiate between quality names and low quality,” Kressin said Jan. 24 by phone. “Once the risk-aversion abates, I think people will start to differentiate again.”

Others say the declines are sowing the seeds of further problems for developing nations.

Weaker currencies will push up overseas debt payments for companies, damping the outlook for their economies, Rashique Rahman, the New York-based co-head of foreign-exchange and emerging-market strategy at Morgan Stanley, said Jan. 23.

“With currency weakness being primarily led by capital outflows, the associated weakness in growth could lead to a reassessment of fiscal health,” Rahman said in a note. “This, in our view, is the next stage in the cycle for EM.”

--With assistance from Ash Kumar in London and Andrea Wong, Liz Capo McCormick, Shin Pei and Joseph Ciolli in New York. Editors: Paul Armstrong, Robert Burgess