LONDON: Billed as one of the winners of the global reflation trade at the start of 2021, emerging market currencies are now struggling with barely a third of the year gone as surging COVID-19 cases turn investors away.
While the US dollar has been generally weak in recent weeks, with the euro punching above the $1.21 level for the first time in two months on Monday, emerging market currencies have floundered. A JPMorgan emerging market currency index is down nearly 2% so far this year.
A weakening greenback is generally seen as a tailwind for emerging markets given their growing reliance on dollars and the earnings boost it gives to their export-oriented economies, but since the pandemic there have been signs of that link faltering.
Developing markets have also been beset with a host of issues this year, including sanctions in Russia, elections in Latin America and monetary policy turmoil in Turkey. Meanwhile fresh waves of COVID-19 infections sweeping through countries from India to Brazil have cast a shadow over the asset class.
“One of the biggest things in FX we are seeing is European outperformance,” said Kunal Shah, global head of EM trading at Goldman Sachs.
“There is not a consistent narrative for emerging markets FX broadly with each country in different stages when it comes to recovering from COVID. And that is holding back investors broadly focused on EM FX as an asset class and prompting them to focus on individual stories.”
Currencies which led EM outperformance earlier this year against the US dollar have suffered this month as COVID cases have jumped. India is poised to register its worst monthly performance since March 2020 as infection rates set a new daily record on Monday.
Morgan Stanley strategist James Lord doesn’t see a good reason to be buying emerging market currencies based on their growth outlook or fundamentals, with the bank neutral on emerging FX.
To be sure, all is not lost. More developed parts of emerging markets are ahead in terms of vaccinations and investors are bullish on prospects for countries like Chile and Israel - the latter where around 81% of citizens or residents over 16 have been fully vaccinated.
With EM growth already expected to exceed the US in the second quarter, emerging market currencies were expensive even before the current spell of weakness.
In comparison, Europe seems to be recovering in recent weeks with the pace of vaccinations picking up in several countries such as Germany and Spain. And with investors already cautious on the outlook of the eurozone economy at the start of the year, the current improvement in rollouts, combined with stabilising European yields, has boosted Europe’s appeal.
Latest data showed net euro positions rose by nearly 2% in the week ending April 20, the first material rise in net positioning since January, considering punters had been consistently trimming their long positions on the euro in 2021. “Europe seems to be finding its mojo on the vaccination front,” said Vasileios Gkionakis, head of FX strategy at Banque Lombard Odier & Cie SA. In comparison, short Brazilian real positions versus the US dollar are near their highest levels since March 2020, according to weekly data.