EM: Looking for a USD bottom after the fed-led rally – TDS

Cristian Maggio, Head of Emerging Markets Strategy at TDS, suggests that they have taken an extra day and several deep breaths to assess the longer-term implications of last Wednesday’s FOMC.

Key Quotes

“Most importantly, we are now asking ourselves how long can the EM FX rally continue for under the assumption that, yes, the Fed has unambiguously turned dovish, more than we had expected and especially more than the market was priced for, but is still set to tighten rates twice this year? This is at least what the last dot revision is telling us and what TD still anticipate. 

It may appear difficult to take a contrarian view when the market is so one-track minded. Yesterday, for instance, all EM currencies without exception posted gains, and in several cases non-trivial ones, against the dollar. This reflected dollar weakness rather than real EM FX strength though, with the numerous EM idiosyncrasies being the catalyst for additional or below-average performance. But the market is failing to recognize that while the direction of US rates is still upwards, no matter how gradual the normalization process is, a great deal of the world remains stuck in a low and declining interest rate environment. 

Therefore, with rate differentials set to continue rising in several markets, we now see the YTD FX performance broadly out of line with the macroeconomic and monetary picture in EMs, in the same vein as the selloff at the start of 2016 was aggressive beyond what was reasonable and was due to reverse. 

Whether or not the FOMC-induced rally will last for a while longer, we see EM FX moves as being already excessive now. It appears clear that currencies are trading at or near the strongest levels vs dollar since the beginning of the year, but this is not always well correlated to their monetary policies or other idiosyncratic risks.”